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Earnings Quality and Stock Returns

Author

Listed:
  • Konan Chan

    (University of Hong Kong and National Taiwan University)

  • Louis K. C. Chan

    (University of Illinois at Urbana-Champaign and Hong Kong University of Science and Technology)

  • Narasimhan Jegadeesh

    (Emory University)

  • Josef Lakonishok

    (University of Illinois at Urbana-Champaign and National Bureau of Economic Research)

Abstract

An exclusive focus on bottom-line income misses important information contained in accruals (the difference between accounting earnings and cash flow) about the quality of earnings. Earnings increases that are accompanied by high accruals, suggesting low-quality earnings, are associated with poor future returns. We explore various hypotheses—earnings manipulation, extrapolative biases about future growth, and underreaction to changes in business conditions—to explain accruals' predictive power. Checks for robustness using within-industry comparisons and data on U.K. stocks are also provided.

Suggested Citation

  • Konan Chan & Louis K. C. Chan & Narasimhan Jegadeesh & Josef Lakonishok, 2006. "Earnings Quality and Stock Returns," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1041-1082, May.
  • Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:3:p:1041-1082
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