An evaluation into the potential use of the quality of earnings concept as a tool in local investment decisions

Abstract

The main aim of the study was to identify a link between the quality of reported earnings and the performance of stock prices. The intention was to overcome the obsession with bottom line earnings and look at company fundamentals with a view to discover the real health of these profits. Numerous articles promoted cash accounting as an absolute tool for identifying how the company was really doing. One such model was developed by Putman, R. et al. (2003). They stated that if earnings were not supported by cash flows, debt payback was elevated and capital expenditures were over and above operating cash, reported profits were deemed to be low quality profits. As a result it was decided to apply the model to those companies listed on the Malta Stock Exchange. Financial statement investigation was subsidised by open ended interviews to stock market experts in order to gain knowledge about the technical aspects of movements in share prices. It was concluded that quality of earnings measures are an indicator of future earnings performance resulting in an appropriate tool for investment decisions, keeping in mind that this factor should not be separated from other important influences which have considerable effect on investment attitudes and therefore on share prices.