Quarterly Accruals or Cash Flows? Return Analysis

This study explores the incremental roles of accruals and net operating cash flows in generating abnormal returns using quarterly and rolling four-quarter data for the entire population of firms, as well as specific industries. Our results show that quarterly net operating cash flow (OCF) is a stronger signal about subsequent quarter’s returns than accruals, and that this result is also true for rolling four-quarter OCF and accruals data. However, when rolling four-quarter OCF and accruals are used to construct portfolios that are held for a whole year, OCF dominates accruals in the first three fiscal quarters, but not in the fourth quarter. Our industry-specific results are consistent with the entire population results; OCF is a stronger signal of future returns than accruals. Investment managers and financial analysts should focus more attention on the OCF than accruals, except possibly for industries where accruals are important in predicting future returns.