Research insight are earnings important a study asked

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RESEARCH INSIGHT Are Earnings Important? A study asked top finance executives of publicly traded companies to rank the three most important measures to report to outsiders. The study reports that: "[More than 50% of] CFOs state that earnings are the most important financial metric to external constituents ... this finding could reflect superior informational content in earnings over the other metrics. Alternatively, it could reflect myopic managerial concern about earnings. The emphasis on earnings is noteworthy because cash flows continue to be the measure emphasized in the academic finance literature." The study also reports that CFOs view year-over-year change in earnings to be of critical impor- tance to outsiders. Why is that? The study provides the following insights. "CFOs note that the first item in a press release is often a comparison of current quarter earnings with four quarters lagged quarterly earnings ... CFOs also mention that while analysts' forecasts can be guided by management, last year's quarterly earnings number is a benchmark that is harder, if not impossible, to manage after the 10-0 has been filed with the SEC ... Several executives mention that comparison to seasonally lagged earnings numbers provides a measure of earnings momentum and growth, and therefore is a useful gauge of corporate performance." Thus, are earnings important? To the majority of finance chiefs surveyed, the answer is a resound- ing yes. (Source: Graham, et aI., Journal of Accounting and Economics, 2005) inanclal Statement Analysis in an Efficient Capital Market Some question the value of financial statement analysis if capital markets are efficient. The idea of market-efficiency is that security prices reflect available information and respond rapidly to w information when it is available. Some people incorrectly believe that this implies there is no gain to engaging in financial statement analysis. However, if our expectations differ from those of other investors there exists an opportunity to make trades based on those beliefs. Market-efficiency requires effort from people to gather information, interpret it, and then ake trades creating supply or demand pressures such that market prices adjust to a new equilib- rium reflecting that information. This task of information gathering and processing is the task of financial analysts and investors. In the U.S. capital markets, the existence of a well-functioning capital market, particularly for the largest firms, allows for buy-side and sell-side analysts, insti- tional investors, and others to fill this role to potentially render prices efficient. For other firms .here there is infrequent coverage in the financial press and little following from investors, prices can be less efficient. Academic research has found many anomalies where markets appear to not fully reflect information or reflect it with a lag.
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