Cash Flows, Asset Values, and Investment Returns

• Published in: Journal of portfolio management Vol. 29; no. 3; pp. 17 - 26
• Main Author: Estep, Preston W.
• Format: Journal Article
• Language: English
• Published: London Pageant Media 30-04-2003
• Subjects: Accumulated depreciation; Balance sheets; Cash flow; Cash flow forecasting; Corporate profits; Declining balance method; Depreciable assets; Discounted cash flow; Earnings; Earnings forecasting; Equity financing; Financial statements; Forecasting techniques; Growth models; Growth rate; Investments; Profitability; Rates of return; Shareholders equity; Stockholders; Studies; United States > US
• ISSN: 0095-4918; 2168-8656
• DOI: 10.3905/jpm.2003.319880

Most methods for forecasting expected returns of stocks are based on earnings. As analysts have justifiably become somewhat wary of earnings reports, they are increasingly interested in developing valuation models that are based on sources and uses of cash. There should be some way to analyze financial statements to make the two approaches give identical results, since the underlying economics are the same. The author provides a convenient formula that states the return expected by an investor in terms of the cash flow/price ratio, some fraction of the growth rate, and changes in valuation (i.e., PE expansion or contraction). The fraction of growth that ends up in the shareholder's pocket will depend on the size of the company's fixed asset accounts, and whether growth is financed by equity sale or debt issuance. [PUBLICATION ABSTRACT]