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Are financial statements still useful?

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Do financial statements remain a valuable source of information for investors when making investment decisions? The answer to that question has generated some serious debate among US and Australian accounting experts.

For investors in the social media giant Facebook Inc., the events besetting the company in March 2018 were tangible in every sense of the word.

So writes Tony Kaye on www.intheblack.com 

Revelations that a now-defunct British political consulting firm, Cambridge Analytica, had been secretly mining the personal data of tens of millions of Facebook users around the world saw almost US$100 billion wiped off Facebook’s US$500 billion market value in just a week, as its shares plunged 18 per cent.

Yet, for investors brave enough to hang on over the following month, and those lucky enough to have bought in at the bottom, there was a silver lining.

Facebook shares rebounded 9 per cent in one day, on 25 April 2018, as the company reported a 63 per cent surge in March quarter net income to US$4.99 billion.

On the surface, using the recent Facebook crisis as a case study, one could readily conclude that there is a definite correlation between company financial statements and share price behaviour.

At the sharp end of this debate is Professor Baruch Lev, head of accounting and finance at New York University’s esteemed Stern School of Business, and co-author of the controversial book The End of Accounting and the Path Forward for Investors and Managers.

Lev and his co-author and fellow US academic, assistant professor Feng Gu at the College of Staten Island, have conducted extensive research, comparing over 60 years of market values of US companies, based on their annual earnings and year-end book values.

What they found “was a continuous and sharp decrease of correlation” between financial results and share price, which Lev says indicates that earnings and book values (net assets) are playing a fast-decreasing role in investor valuations.

“We show that even if you predicted all American companies that would either exactly meet or beat the analysts’ forecasts of earnings, while you would have made huge amounts of money in the ’80s and early ’90s, today it basically is almost zero,” Lev says.

The earnings don’t measure changes of values as they used to. To focus on earnings as many financial analysts are still doing, with all the spreadsheets that they have, which are basically aimed at predicting future earnings, is just a futile exercise.”

But what holds true in the US isn’t universal, and a team of researchers in Australia, funded by CPA Australia, has found that company earnings and balance sheets here do have a stronger correlation with market values.

Read more on www.intheblack.com