Testing the Accruals and Cash Flows Anomalies for the Indian Stock Market

Abstract

This study examines the persistence of earnings performance, the contribution of accruals and cash flows in the persistence of earnings and whether investors correctly value the information contained in earnings, accruals and cash flows for equity pricing. We use data for 493 companies on the BSE from Jan 1997 to Dec2010. Results support the high persistence of earnings for the sample firms and that the stock prices correctly reflect the implications of current earnings for future earnings. We find that earnings persistence is more attributable to cash flows than accruals. However the Indian investors seem to under price accruals and overprice cash flows which is in contrast to findings for mature markets. Accruals are found to be positively associated with future returns. The accrual anomaly is not captured by one factor CAPM but is fully explained by the three factor Fama French model due to risk premium on the size factor. A negative relationship is reported between cash flows and returns which is again contrary to the results for mature markets. The cash flow anomaly which is not absorbed by CAPM is explained by the size and value factors of the Fama French model. Hence accruals and cash flow anomalies do not pose serious challenge to popular asset pricing models in the Indian context. Our findings shall be highly useful for investment analysts and portfolio managers who are in pursuit of trading strategies that promise extra normal returns. The research contributes to asset pricing and behavioural finance literature especially for emerging markets.