The end of accounting

Every fund house and brokerage that markets its money-management expertise to investors claims that it follows a process steeped in 'fundamental research'. The implicit assumption is that corporate earnings drive stock prices over the medium to long term and by making reliable forecasts of these earnings, a portfolio can be positioned for better-than-benchmark performance. But what if this were not quite the case? What if reported earnings were unable to adequately explain future price movements? Baruch Lev, a professor at NYU Stern School, and Feng Gu of the University of Buffalo published The End of accounting and the Path Forward for investors and Managers in 2016. It makes compelling reading even while dealing with a subject as dry as accounting. Usefulness of financial information Quoting from Financial Accounting Standards Board, USA, the authors point out, "The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity." To measure how much store the equity market puts in financial numbers, Lev and Gu chose earnings or net profits and book value and regressed

This article was originally published on November 13, 2018.