Starbucks Financial Statement Analysis

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ACCOUNTING HORIZONS Vol. 18, No. 4 December 2004 pp. 263–XXX

How Do Earnings Numbers Relate to Stock Returns? A Review of Classic Accounting Research with Updated Evidence
D. Craig Nichols and James M. Wahlen
SYNOPSIS: An extensive body of academic research in accounting develops theory and empirical evidence on the relation between earnings information and stock returns. This literature provides important insights for understanding the relevance of financial reporting. In this article, we summarize the theory and evidence on how accounting earnings information relates to firms’ stock returns, particularly for the benefit of students, practitioners, and others who may not yet have been exposed to this literature. In addition, we
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We use the updated empirical analysis to assess the extent to which the findings in three seminal papers still hold, and provide some additional results that do not appear in the original work. This paper can serve as a resource for those interested in a deeper appreciation for the capital market consequences associated with accounting earnings. We organize this review using the three theoretical links between earnings and share prices developed by Beaver (1998). These “three links” are: 1) current period earnings provides information to predict future periods’ earnings, which 2) provide information to develop expectations about dividends in future periods, which 3) provide information to determine share value, which represents the present value of expected future dividends. We describe how this theoretical structure provides a practical framework for analyzing and understanding the valuation implications of earnings information in the capital market. We then provide empirical evidence on the relation between earnings and stock returns by extending three classic studies using data from 1988 through 2002. Our first set of empirical results provides evidence on links 1–3 by showing a
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