The Usefulness of Accrual Earnings, Cash Flows, and Working Capital in the Construction of Accounting-Based Investment Strategies

Roland Lipka
Temple University

Jeong Bon Kim
Hong Kong Polytechnic University

Heibatollah Sami
Temple University

Abstract: Accounting earnings have been evaluated as the premier measure of performance in association studies of price and earnings (Dechow 1994; Biddle, Seow and Siegal 1995). In this study we use an alternative criterion to compare the usefulness of different measures of firm performance. Instead of comparing relative explanatory power of the different measures, we evaluate the usefulness of the three competing measures by using an investment trading strategy. Our goal is to ascertain whether investment performance also supports the findings of the information usefulness studies that accounting earnings is the premier measure of performance. We find evidence that accrual earnings is more useful than working capital or cash flow as a selection criterion for market returns of firms that appear to be underpriced. These results persist even after adjusting for size effects.

Back to Program