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Bridge over ocean
1 March 2007 Financial Analysts Journal Volume 63, Issue 2

Is Cash Flow King in Valuations?

  1. Jing Liu
  2. Doron Nissim
  3. Jacob Thomas

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. The question
addressed in the article is whether the balance tilts in favor of cash flows
when the following are considered: (1) forecasts rather than reported numbers,
(2) dividends rather than operating cash flows, (3) individual industries rather
than all industries combined, and (4) companies in non-U.S. markets. In all
cases studied, earnings dominated operating cash flows and dividends.

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