Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

CONCLUSION

Is cash flow king in equity valuation? Our analysis suggests that it is not. In Liu et al. (2002), we found that reported earnings dominate reported cash flows as summary measures of value in the United States. In the current study, we extended the analysis to other markets and used forecasts of operating cash flows, dividends, and earnings. We found that, although moving from reported numbers to forecasts improves the performance of operating cash flows, it improves the performance of earnings to an even greater extent. EPS forecasts represented substantially better summary measures of value than did OCF forecasts in all five countries examined, and this relative superiority was observed in most industries.

When we compared dividends rather than operating cash flows with earnings for a sample derived from seven countries where dividend forecasts are common, we found, again, that earnings forecasts were a better summary measure of value than dividend forecasts in all countries and most industries. And we found that moving from reported numbers to forecasts improved performance more for earnings than for dividends.

Overall, our results suggest that proponents of cash flow multiples should consider using earnings multiples instead because valuations based on earnings forecasts are remarkably accurate for a substantial majority of companies. The increased availability of earnings forecasts should be an impetus to use earnings multiples.

We conclude with three caveats. First, ...