A Comparison and Analysis of the Role of Earning and Cash Flow in Explaining Long Run Return

The study of the relationship between stock return and accounting earning is so critical for studying of the efficiency of capital market as well as for evaluating the usefulness of information on financial statements. Accounting earning is one of the most important items of the financial statements used by stakeholders as a basis for making decisions and predictions. By using six different models, this study attempted to investigate the relationship between the return and accounting earning. The results of this relationship, then, were compared with the cash flow model which studies the relationship between stock return and cash flow. Despite other studies, this study tried to evaluate the explanatory power of each of the proposed models in the long run. The researcher wanted to find an answer to the research question: "Which one of the variables of earning or cash flow is more powerful in explaining the long run return?" Moreover, the other important question was to discover: "Which model is more suitable for investigating the relationship between the variables mentioned in basic financial statements and stock return?" The results showed that in all models the correlation coefficient increased as the measurement interval was lengthened. However, there was not a significant difference among the correlation coefficients obtained from the different models. Accounting earning was the only variable which in all levels and in all models had a meaningful correlation with return. Furthermore, the results showed that there was a meaningful relation between the stock return and cash obtained from operational activities in a long interval. However, the explanatory power of earning models in the long run was more than the cash model.