Academics [Er, shouldn’t that be ‘kids’? Ed.] say the funniest things.
Sometimes when you look at some work from academia, as with the paper today, as a practitioner you know the answer to a headline question right away. The proofs are just a formality. Hopefully, anyone else also engaged at the sharp end of things financial will have the same response as me to the question headlining this post; which was, ‘duh-uh?!’
Professor Stephen Foerster from the Western University with the assistance of John Tsagarelis and Grant Wang from Highstreet Asset Management in the paper highlighted today drilled the S+P 1500 for the period October 1994 to December 2013 for a more rigorous response however. In the process they discovered that superior cash flow characteristics are among THE most important predictors of stock returns.
They also remind that IFRS ‘..and US GAAP encourage companies to use the direct method of financial statement presentation for reporting operating cash receipts and payments.’ but most companies still report using the indirect method. In Appendix A from P. 25 they provide a useful theoretical comparison that reminds why the former is so much more intuitive and therefore useful.
It’s never a bad thing to be reminded of something you sort of know but can’t quite remember why; but seriously gentlemen? Are you suggesting anyone other than know-nothing talking-heads on financial TV look at reported profits as a reliable guide to the value of a business and/or it’s future prospects?
There seems to be a meme floating at present that somehow (with U.S. companies in particular) accounting ‘tricks’ are being more widely used to bamboozle investors than in the past. This is a nonsense. There are no ‘tricks’ that are reliable over time unless, as with option expenses, investors are turning a regular blind eye to accounting shenanigans in light of a broad advance in stock prices?
Oooh, come to think of it, that does describe the U.S. stock market over the last seven-plus years? You have been warned (to read report and accounts from cover to cover, as all good analysts do!).
You can access the paper in full via this link Are Cash Flows Better Stock Return Predictors Than Profits?
Happy Sunday.