The Ability of Earnings to Predict Future Operating Cash Flows Has Been Increasing - Not Decreasing

Abstract

We investigate the relationship between earnings and future operating cash flows over the 1980s and the 1990s. Although the extant research indicates a weakening relationship between earnings and contemporaneous stock returns over time, we find that the relationship between earnings and future operating cash flows has increased over time. This result holds for older (surviving) firms and newer firms, dividend paying and non-paying firms, firms that earned profits or incurred losses, and for small and mid-sized firms. Large firms showed neither improvement nor deterioration. Out-of-sample predictions of operating cash flows shows increasing forecast accuracy over time for one, two, and three year-ahead cash flows.

Keywords: earnings, cash flows, cash flow forecasts

JEL Classification: G12, M41