The Relative and Incremental Explanatory Power of Earnings and Alternative (to Earnings) Performance Measures for Returns

We analyze the ability of earnings and non-earnings performance metrics to explain the variability in annual stock returns for industries where we identify, ex ante, an allegedly preferred (for valuation purposes) summary performance metric. We identify three industries where earnings before interest, taxes, depreciation, and amortization (EBITDA) and cash from operations (CFO) are preferred, and three industries where specific non-GAAP performance metrics are preferred. As a benchmark, we also examine the ability of EBITDA and CFO to explain returns for seven industries for which earnings is the preferred metric. Results for the benchmark earnings industries show that earnings dominates EBITDA and CFO in explaining returns. All other results are inconsistent with the view that perceptions of preferred metrics are reflected in actual aggregate investment behaviors.

[1]  Carla K. Hayn.  The information content of losses , 1995 .

[2]  Richard A. Riley,et al.  Using Nonfinancial Information to Predict Financial Performance: The Case of the U.S. Airline Industry , 1999 .

[3]  Linda Vincent,et al.  The information content of funds from operations (FFO) for real estate investment trusts (REITs) , 1999 .

[4]  Q. Vuong.  Likelihood Ratio Tests for Model Selection and Non-Nested Hypotheses , 1989 .

[5]  R. Ball,et al.  An empirical evaluation of accounting income numbers , 1968 .

[6]  Patricia M. Dechow.  Accounting earnings and cash flows as measures of firm performance : The role of accounting accruals , 1994 .

[7]  Larry R. Gorman,et al.  Timely Industry Information as an Assurance Service: Evidence on the Information Content of the Book-to-Bill Ratio , 1999 .

[8]  Accruals and the Prediction of Future Cash Flows , 1999 .

[9]  J. MacKinnon,et al.  Several Tests for Model Specication in the Pres-ence of Alternative Hypotheses , 1981 .

[10]  S. Kothari,et al.  An analysis of intertemporal and cross-sectional determinants of earnings response coefficients , 1989 .

[11]  William H. Beaver,et al.  The incremental information content of replacement cost earnings , 1982 .

[12]  Uday Chandra,et al.  The Use of Trade Association Disclosures by Investors and Analysts: Evidence from the Semiconductor Industry* , 1999 .

[13]  Eric W. Noreen,et al.  Incremental Information Content of the Change in the Percent of Production Added to Inventory , 1997 .

[14]  Siew Hong Teoh,et al.  Are Accruals during Initial Public Offerings Opportunistic? , 1998 .

[15]  Judy Rayburn,et al.  THE ASSOCIATION OF OPERATING CASH FLOW AND ACCRUALS WITH SECURITY RETURNS , 1986 .

[16]  B. Lev,et al.  Value-Relevance of Nonfinancial Information: The Wireless Communications Industry , 1996 .

[17]  G P Wilson,et al.  THE RELATIVE INFORMATION-CONTENT OF ACCRUALS AND CASH FLOWS - COMBINED EVIDENCE AT THE EARNINGS ANNOUNCEMENT AND ANNUAL-REPORT RELEASE DATE , 1986 .

[18]  Peter Easton,et al.  EARNINGS AS AN EXPLANATORY VARIABLE FOR RETURNS , 1991 .

[19]  Gary C. Biddle,et al.  Relative Versus Incremental Information Content , 1995 .

[20]  Shivaram Rajgopal,et al.  Does the Stock Market Fully Appreciate the Implications of Leading Indicators for Future Earnings? Evidence from Order Backlog , 2001 .

[21]  S. Kothari.  Price-earnings regressions in the presence of prices leading earnings: Earnings level versus change specifications and alternative deflators , 1992 .

[22]  Gary C. Biddle,et al.  Does Eva Beat Earnings? Evidence on Associations with Stock Returns and Firm Values , 1997 .