An investigation of the quality of earnings concept as applied to defense contractors.

Abstract

This thesis analyzes whether the quality of earnings concept can be usefully employed in the security analysis of defense contractors. Background is provided by an extensive review of the literature relevant to quality of earnings. Since the quality of earnings concept is very subjective, specific quantitative measures of quality of earnings are developed and used in a statistical analysis to validate the variables as explanatory predictors of a firm's price earnings (P/E) ratio. The statistical techniques employed include Pearson's Product Moment Correlation, Spearman's Rank Order Correlation, stepwise regression and other multiple linear regression models. Results of the study suggest that there are significant relationships between several hypothesized quality of earnings variables and a firm's P/E ratio. The statistically significant variables in the final regression models explain between 67.8% and 76.6% of the variation in the P/E ratio. The evidence indicates that variables related to cash flow, degree of government business, order backlogs and earnings stability reflect aspects of a firm's quality of earnings.