To beat or not to beat? The importance of analysts’ cash flow forecasts

We examine the sophistication of analysts' cash flow forecasts to better understand what accrual adjustments, if any, analysts make when forecasting cash flows. As a preliminary step, we first demonstrate that prior empirical tests used to evaluate the sophistication of analysts' cash flow forecasts are not diagnostic. We then present three sets of evidence to triangulate our conclusion that analysts' cash flow forecasts incorporate meaningful accrual adjustments. First, we review a stratified random sample of 90 analyst reports and find that the majority of these analysts include explicit adjustments for working capital and other accruals in their cash flow forecasts. Second, using a large sample of analysts' cash flow forecasts from 1993–2008, we find that these forecasts outperform time‐series cash flow forecasts in correctly predicting the sign and magnitude of accruals. Finally, we find a significant market reaction to analysts' cash flow forecast revisions, suggesting that investors find these revisions informative. Collectively, our findings demonstrate that analysts' cash flow forecasts are not simply naïve extensions of their own earnings forecasts, but that they reflect meaningful and useful accrual adjustments. These findings are relevant to researchers who examine analysts' cash flow forecasts in a variety of settings, and to investors and practitioners who employ these forecasts for valuation purposes.

Section: Introductionsupporting

confidence: 86%

Section: Introductionmentioning

confidence: 99%

Are Analysts' Cash Flow Forecasts Naïve Extensions of Their Own Earnings Forecasts?

Call¹,

Chen

Tong

2013

“…Early research investigated the determinants of investors’ demand for cash flow forecasts (DeFond and Hung ) and the effect of weak investor protection on cash flow forecast disclosure around the world (DeFond and Hung ). Later research has examined the effect of cash flow forecasts on managers’ earnings reporting (McInnis and Collins ), cash flow forecast availability and analyst earnings‐forecasts accuracy (Call et al ), the market reaction to firms meeting or beating analysts’ cash flow forecasts (Brown et al ), the determinants of cash flow forecast accuracy (Pae and Yoon ), and the relation between earnings quality and analysts’ decisions to issue cash flow forecasts (Bilinski ). Despite the considerable focus on analyst cash flow forecasts in the recent literature, there is a lack of information on their usefulness for the ultimate output of analyst research, that is, their valuations in the form of target prices.…”

Section: Research Hypothesesmentioning

confidence: 99%

Do Analysts’ Cash Flow Forecasts Improve Their Target Price Accuracy?

Hashim

Strong²

2018

The literature on the usefulness of analysts’ cash flow forecasts is unsettled, with Call et al. (), Mohanram (), and Radhakrishnan and Wu () providing evidence in favor of their usefulness, and Givoly et al. (), Bilinski (), and Ecker and Schipper () questioning this. Target prices provide a good setting to test the usefulness of cash flow forecasts because they are an ultimate output of an analyst's valuation process to which cash flow forecasts are an input. Moreover, studying the effect of cash flow forecasts on target prices is more relevant for assessing their usefulness than is studying their effect on earnings‐forecast accuracy, as the accuracy of target prices requires a comparison with market prices, which are less subject to management influence than reported earnings. By improving an analyst's understanding of unexpected accruals and permanent earnings, a cash flow forecast can increase an analyst's target price accuracy and signal an analyst's superior forecasting ability. We examine whether, conditional on their earnings forecasts, analysts’ cash flow forecasts improve their target price accuracy. We find that when analysts issue cash flow forecasts, their target price accuracy increases. We also find that this accuracy increases with the accuracy of their cash flow forecasts. Finally, we find that this increased target price accuracy is greater for more challenging‐to‐value firms. Our study provides confirmatory evidence of the usefulness of analysts’ cash flow forecasts.

“… We do not examine the incentive to meet‐or‐beat analysts' cash flow forecasts (Brown et al ), or whether optimistic vs. pessimistic cash flow forecasts are more likely to encourage tax avoidance.…”

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confidence: 99%

Do Analysts' Cash Flow Forecasts Encourage Managers to Improve the Firm's Cash Flows? Evidence from Tax Planning

Ayers¹,

Call

Schwab

2018

Recent research finds that analysts' cash flow forecasts have meaningful financial reporting ramifications, but, to date, the identified effects are unlikely to yield meaningful cash flow benefits. This study examines whether analysts' cash flow forecasts encourage managers to enhance the firm's cash flow position through tax avoidance activities. We evaluate the change in cash tax avoidance after analysts begin issuing cash flow forecasts relative to a propensity score matched control sample of firms without cash flow forecasts. Consistent with analysts' cash flow forecasts encouraging tax avoidance that enhances the firm's cash flow health, we find a negative association between cash tax payments and analysts' cash flow coverage. Additional analysis suggests this association is driven primarily by strategies to permanently avoid rather than to temporarily defer tax payments and that increased cash tax avoidance activity represents a nontrivial component of the overall increase in reported operating cash flows after the initiation of analysts' cash flow coverage.