Evidence that accounting earnings are not very well correlated with share prices

Evidence that earnings window-dressing doesn't improve share prices

Evidence that the market evaluates management decisions based on their expected long-term cash flow impact, and not on their short-term earnings impact

Empirical Proof of Low Correlation Between Accounting Earnings and Share Prices

According to the accounting model, a strong correlation should exist between EPS growth and shareholder returns. However, a study shows that there is hardly any correlation with Pearson's Coefficient being as low as 0.17.

The study included the companies under BSE-100 Index. Average EPS growth was calculated by considering the data for the past 4 years (2000-2004). When similar study was conducted in US capital markets, the Pearson's Coefficient was 0.088.

In many ways, the venerable P/E ratio is a blunt instrument. All it tells you is that one stock is selling for 10 times its earnings per share, and another is selling for 30 times earnings. And yet the two companies could be in completely different industries, and could also be at completely different stages of development. Should they be valued in the same way? Most analysts would argue that they shouldn't.

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* Contributed by: -
Varun Dawar,
PGDBM, Batch 2004-06,
Institute of Management Technology (IMT), Ghaziabad.