Cash flow signals and analysts' earnings forecast revisions

Abstract

This study investigates the incorporation of cash flow information in forecasts of earnings made by security analysts. It extends and links two streams of research in accounting. One stream of research has been concerned with revisions in earnings forecasts made by analysts. What factors lead to forecast revisions? Prior research has concentrated on investigating revisions of earnings forecasts in response to earnings announcements. A critique of that literature notes that there is a lack of knowledge concerning other factors that lead to forecast revisions (Brown, et al., 1985, p. 130). This study extends that research by identifying accounting measures beyond earnings apparently deemed informative to analysts when predicting future earnings. The second stream of research has been concerned with the question of whether a decomposition of earnings into cash flow and accrual components provides incremental information beyond that contained in earnings alone.à ¢ Is such a decomposition informative? Is a dollar of accrual accounting earnings (worth) the same as a dollar of cash flow? Prior research has investigated this question through analysis of security returns. Findings have been somewhat contradictory. This study extends that research by addressing the question of the use of earnings component information in the previously unexamined context of the formation of analysts' earnings forecasts. In doing so, the study provides evidence on the signal conveyed by earnings components as perceived by one major group of users of accounting information.