In September 2022, James Comtois of ETF Trends covered my research paper on free cash flow versus earnings as measures of corporate profitability. The article highlighted the central argument of my white paper: that free cash flow provides a more reliable picture of a company’s financial health than GAAP earnings.
As I wrote in the paper:
“Investors who rely on earnings to assess a company’s intrinsic equity value and predict future stocks return may suffer from a significant magnitude of management manipulation. Unlike earnings, free cash flow provides a better picture of a company’s profits because it doesn’t require managers to estimate the realization of future cash flows related to contemporaneous accruals, leaving much less space for discretionary accounting, and becomes less sensitive to the level of uncertainty in reflecting firm profitability.”
The article noted that a survey of 400 CFOs found that 20% of companies intentionally distort earnings even while adhering to GAAP, with the magnitude of misrepresentation averaging 10% of reported earnings.
Read the full article: ETF Trends — Why Free Cash Flow Better Determines Profitability Than Earnings
My original research paper is available here: Free Cash Flow Investing: Profitability or Yield?