U.S. accounting laws require all public companies to use the accrual accounting method, which has an impact on a company’s financial statements. In this week’s digest, AAII staff highlight what accrual data can reveal about a stock when making investing decisions.
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Using Accruals to Judge How Persistent Earnings Will Be |
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By Charles Rotblut, CFA
One method of judging how aggressive a company’s executives are being with their accounting decisions is to look at accruals. Accrual accounting recognizes transactions when their economic benefits become probable. Cash accounting, conversely, recognizes transactions when cash exchanges hands. In the article Using Accruals to Judge How Persistent Earnings Will Be, AAII Journal editor Charles Rotblut explains how investors can utilize accrual ratios to evaluate the risk of stocks.
Some of the topics covered in the article include:
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How accruals work
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The key risks of accruals
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A guide to analyzing a company’s reliance on accruals
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Accruals’ effect on stock returns
Since accruals aren’t discussed much on financial websites, using accruals to assess earnings quality gives you an advantage when analyzing stocks.
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Stocks With Attractive Accrual Ratios |
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By John Bajkowski
While most investors focus on earnings to measure profitability and company success, it can be insightful to see if cash flow generation corresponds with earnings. Earnings are calculated under the principles of accrual accounting, while cash flow measures the direct consumption and generation of cash. An accrual is any recorded amount that isn’t a cash transaction, including accounts receivable, accounts payable, allowances and reserves. So, earnings are influenced by these factors even if no cash was used or created in the process. This First Cut stock screen seeks out companies where cash flow exceeds net income relative to average total assets.
Some of the differences covered in the article include:
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How to measure accruals in your analysis
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Calculating an “accrual ratio”
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How accruals impact future stock prices
Research shows that companies in which non-cash accruals strongly increased earnings (positive accruals) underperformed the companies in which cash flow exceeded earnings (negative accruals). Learn to use the accrual ratio as another valuable tool to use in the search for attractive stocks.
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Member Question
Are you making any finance-related resolutions for 2020/2021?
A) Yes
B) No
C) Unsure
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Be sure to vote on this week’s question for the opportunity to offer your insights on our open-ended question. |
Previous Question’s Results
Which investing profile best fits your portfolio allocation approach?
Moderate : 56%
Aggressive : 30%
Conservative : 14%
Poll results are as of 9 a.m. (Central) on Monday. 2,911 respondents.
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AAII Survey: What Investing Profiles AAII Members Follow |
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Investors come in all shapes and sizes. And unlike your birth date, your investor profile is likely to change over time. Life events, career shifts and of course how much time you have to achieve a goal all play a part at a given point in time. This week we looked to see what investing profile AAII members follow and how their profile has changed over time. More » |
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From the Archives: Financial Statement Analysis Articles |
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 Learn everything you need to know about how to read and understand company financial statements in the AAII online archives. A popular series by former AAII financial analyst Joe Lan from 2012 explains the balance sheet, the income statement and the cash flow statement in clear detail. To take you a step further, he wraps up with an explanation of 16 essential financial ratios and how they reveal a company’s strengths and weaknesses. More » |
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