This paper identifies cash-flow news and expected-return news in financial statements and shows that stock returns are increasing with positive cash-flow news in the statements and decreasing in the news about increasing expected returns. The identified news measures differ significantly from those identified from decomposing returns based on the Vuoltennaho (2002) framework. The paper points to the realization principle, associated as it is with the resolution of uncertainty, as the accounting feature that conveys expected-return news, a feature that is not captured by the accounting implicitly assumed in the Vuolteenaho framework. The expected-return news we identify forecasts changes in both stock return betas and earnings betas. The expected-return news also predicts future returns while cash-flow news (appropriately) does not. Financial statements distinguish expected-return news associated with operations from that associated with financing activities, and both exhibit properties required of cash-flow news and expected-return news variables. In contrast, the measures from the return decomposition approach fail consistency requirements for variables to be identified as cash-flow news and expected-return news.
Penman, Stephen, and Nir Yehuda. "A Matter of Principle: Accounting Reports Convey both Cash-flow News and Discount-rate News." Columbia Business School, June 2015.
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