Accruals,Cash Flows And Expected Return

Profit is consisted of two parts:accruals and operating cash flows. As profit is a key factor in evaluating enterprise management, accruals and operating cash flows thus play a vital role in predicting an enterprise's future profit. The operating cash flow, as defined by accounting postulates of our country, refers to the increase and decrease in cash due to trade or other businesses, i.e. the influx and outflow of cash. One function of accrual is to combine with accounting earnings to show the performance of enterprise management that has not yet been turned into cash. Since accrual is closely linked with the accounting personnel, the latter could easily manipulate the former. In comparison, the operating cash flow is less likely to be manipulated by accounting personnel, since its calculation requires less assumptions than that of accrual. That is why in general the operating cash flow reflects the enterprise management more accurately. A too large amount of accrual may result from a low quality of earnings, while more operating cash flow possibly means a higher quality of earnings. A reasonable grasp of the effect of accrual and operating cash flow upon future enterprise profit benefits the investors in choosing better shares, and also helps administrators to adjust their asset structure in a more suitable way. Which of the two, accrual and operating cash flow, can predict the future profits of stocks more effectively is the focus of this thesis.Foreign scholars generally agree that the effect of operating cash flow is bigger than that of accruals in determining future profits. The majority of scholars in China tend to study accounting earnings and operating cash flow and by comparing the value relevance of the two, concluding that the former one's value relevance higher than the latter. However, such research were mostly conducted before 2002. between 2003 and 2009, a series of changes and adjustments were adopted in the accounting system, accompanied by an continuing increase in the number of investors. So the previous research is not adequate to analyze the market today.The subject of this paper is the domestic A share market. Based on statistics from January,2003 to January,2010,this is an empirical study of the effect of accrued profit and operating cash flow to compare their predictive ability. By cross grouping method, this thesis finds that the operating cash flow can better predict future profits of individual share. Then, this paper resorts to Multiple regression method to check the conclusion. The results of time series regression, cross-section regression and panel date regression all state clearly that operating cash flow can more effectively predict the future profits of individual share than accrued profits.The conclusions above infers that by using a system of buying a set of shares with high operating cash flow and selling another set with low operating cash flow, investors can gain excess profits. To verify whether the excess profit is only relevant to operating cash flow, this thesis employs the standard capital asset pricing model, the Fama and French three-factor model to verify whether the excess profit is also influenced by market risk factors. The results show that in general terms, excess profit is not related to market risk factors. It is the operating cash flow that results in excess profit.