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Analysts’ Cash Flow Forecasts and the Decline of the Accruals Anomaly

Last Updated on 10 February, 2024 by Rejaul Karim

The academic paper titled “Analysts’ Cash Flow Forecasts and the Decline of the Accruals Anomaly” authored by Partha S. Mohanram of the Rotman School of Management at the University of Toronto delves into a perplexing financial phenomenon.

The accruals anomaly, as illuminated by Sloan (1996), yielded consistent excess returns for over four decades until 2002, yet appears to have waned in subsequent years. This paper provocatively posits that the surge in analysts’ cash flow forecasts has played a pivotal role in this anomaly’s decline.

By demonstrating a discernible weakening of the negative relationship between accruals and future returns in the presence of cash flow forecasts, the study unveils an evolving financial landscape.
Moreover, the findings underscore the increasing influence of analysts’ cash flow forecasts in shaping the accurate valuation of stocks, offering an engrossing commentary on the evolving dynamics of market mispricing and equity valuation.

Abstract Of Paper

The accruals anomaly, demonstrated by Sloan (1996), generated significant excess returns consistently for over four decades until 2002, but has apparently weakened in the subsequent period. In this paper, I argue that one factor responsible for this decline is the increasing incidence of analysts’ cash flow forecasts that provides markets with forecasts of future accruals. The negative relationship between accruals and future returns is significantly weaker in the presence of cash flow forecasts. This anomalous relationship becomes weaker with the initiation cash flow forecasts but continues after cash flow forecasts are terminated. Further, the mitigating effect of cash flow forecasts is greater for forecasts that are more accurate. The results are incremental to explanations based on the improved accrual quality, reduced manipulation of special items and restructuring charges and greater investment in accruals strategies by hedge funds and highlight the increasing importance of analysts’ cash flow forecasts in the appropriate valuation of stocks.

Original paper – Download PDF

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Author

Partha S. Mohanram
Rotman School of Management, University of Toronto

Conclusion

In conclusion, “Analysts’ Cash Flow Forecasts and the Decline of the Accruals Anomaly” by Partha S. Mohanram offers a compelling insight into the evolution of the accruals anomaly and its relationship with analysts’ cash flow forecasts.

The seminal work of Sloan (1996) underscored the robust nature of the accruals anomaly, which yielded substantial excess returns for over four decades before experiencing a decline post-2002. This study presents a cogent argument attributing this decline to the increased prevalence of analysts’ cash flow forecasts, which provide markets with insightful predictions of future accruals.

The results compellingly demonstrate a diminishing negative relationship between accruals and future returns in the presence of cash flow forecasts, signaling an evolving financial landscape.
Furthermore, the study elucidates that the mitigating effect of accurate cash flow forecasts on this relationship underscores their amplified significance in equity valuation.

Notably, these findings augment existing explanations and emphasize the burgeoning influence of analysts’ cash flow forecasts in appraising stocks, affirming the escalating importance of such forecasts in the contemporary financial paradigm.

Related Reading:

Anomalies Abroad: Beyond Data Mining

Equity Anomalies and Idiosyncratic Risk Around the World

FAQ

What is the focus of the academic paper “Analysts’ Cash Flow Forecasts and the Decline of the Accruals Anomaly”?

The paper focuses on the decline of the accruals anomaly, as identified by Sloan (1996), which historically generated consistent excess returns for over four decades until 2002. The author, Partha S. Mohanram, proposes that the increasing prevalence of analysts’ cash flow forecasts has played a significant role in the observed decline of the accruals anomaly.

What is the main argument presented in the paper regarding the decline of the accruals anomaly?

The main argument is that the surge in analysts’ cash flow forecasts has contributed to the decline of the accruals anomaly. The paper posits that analysts’ cash flow forecasts provide markets with predictions of future accruals, leading to a weakening of the negative relationship between accruals and future returns.

How does the paper demonstrate the relationship between analysts’ cash flow forecasts and the accruals anomaly?

The paper demonstrates that the negative relationship between accruals and future returns is significantly weaker in the presence of analysts’ cash flow forecasts. The weakening of this relationship persists even after the termination of cash flow forecasts. The mitigating effect of cash flow forecasts is shown to be greater for forecasts that are more accurate.

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