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Academic Support - Reading

Cash flow is king: Cognitive errors by investors by Todd Houge & Tim Loughran

Published in the Journal of Psychology and Financial Markets (Vol 1, Nr 3&4, 2000, p.161-175)

“When investors fixate on current earnings, they commit a cognitive error and fail to fully
value the information contained in accruals and cash flows. Extending the accrual
anomaly documented by Sloan [1996], we identify significant excess returns from a cash
flow-based trading strategy. The market consistently underestimates the transitory nature
of accruals and the long-term persistence of cash flows. We find that the accrual anomaly
derives from the poor performance of high accrual firms, which are more likely to
manage earnings. Combining the accrual and cash flow information also reveals that
investors misvalue the quality of earnings. Contrary to Fama [1998], these anomalies are
robust to the three-factor model with equally or value-weighted portfolio returns.”

Show me the cash flow by Alfred Rappaport

Published in the Fortune Magazine, September 18, 2002

Rappaport is an authoritative source on matters of accounting. This article sets forth the reasons why current income statement accounting is a failure. Rappaport sets forth the basic principles for analyzing cash flow and for making the necessary adjustments in the income statement to reveal what is happening to the company’s liquidity. Rappaport calls the statement resulting from his adjustments the “value relevant income statement.”