Cash Flow is King? Comparing Valuations Based on Cash Flow Versus Earnings Multiples

Abstract

Contrary to the common perception that operating cash flows are better than accounting earnings at explaining equity valuations, recent studies suggest that valuations derived from industry multiples based on reported earnings are closer to traded prices than those based on reported operating cash flows. We extend those analyses to determine if the balance tilts in favor of cash flows when we consider a) forecasts rather than reported numbers, b) dividends rather than operating cash flows, c) individual industries rather than all industries combined, and d) firms in other markets beyond the U.S. Our main finding is that in all venues cash flows (both operating and dividends) are dominated by earnings. Our results imply that those seeking quick valuations should use multiples based on forecasted earnings, since they are remarkably close to traded prices.

Keywords: cash flows, earnings, valuation, multiples

JEL Classification: G12, G14, G29, G35, M41