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  3. Examining the relationship between growth opportunities and profit stability in free cash flow valuation

Examining the relationship between growth opportunities and profit stability in free cash flow valuation

Number of pages: 75 File Format: word File Code: 31233
Year: 2013 University Degree: Master's degree Category: Management
Tags/Keywords: Company development - Free cash flow - Free cash flow valuation - Free cash flows - Growth opportunities - Investment - profit - stock - Sustainability of profits
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  • Summary of Examining the relationship between growth opportunities and profit stability in free cash flow valuation

    Chapter 1

    Generalities of the research

    1- Introduction

    The growth and development of joint-stock companies over time led to the emergence and increase of a class of capital owners who did not directly participate in the management of the companies and guided and monitored the company's affairs through the selection of the board of directors. This new development created a new group of professional managers who had little or no share in the capital of the institutions they managed, and thus the management of the institutions was separated from the ownership of their capital (Shabahang et al., 2017). The separation of management from ownership caused a conflict of interests between managers and shareholders and the emergence of the agency theory problem. Agency theory, which separates ownership and control in companies, creates a conflict of interests between shareholders and company managers. One of the most beautiful forms of fundamental analysis of securities is evaluating the cash flows of a business unit. Because this method directly connects the value of a company and the economic efficiency of its assets (Derja, 2019). Free cash flow is a measure to measure the company's performance and shows the cash that the company has after making the necessary expenses for the maintenance or development of the assets. Free cash flow is important in that it allows the company to seek opportunities and increase shareholder value. Without having cash, it is not possible to develop new products, conduct business studies, pay dividends to shareholders and reduce debts. On the other hand, cash must be kept at a level that balances between the cost of maintaining cash and the cost of insufficient cash.

    In this chapter of the research, the statement of the investigated problem, the statement of the necessity of conducting the research, the conceptual model of the research, the research objectives, the research questions, the scope of the research (spatial, temporal and thematic domain) have been discussed. Jensen [1] (1986), a company with low investment opportunities is expected to have high free cash flows. Because as the investment opportunities (actually and potentially) increase, most of the surplus funds are used to increase the shareholders' wealth by investing in the existing opportunities, and an increase in the amount of investment from the surplus funds will lead to a decrease in these funds. Therefore, according to Jensen's opinion and agency theory, the conflict of interest between managers and shareholders is aggravated when the company generates significant (positive) free cash flows and faces few growth opportunities. In the absence of control measures by shareholders, managers of companies with positive free cash flow [2] and low growth opportunities, first invest in projects with positive net present value [3] and due to low growth opportunities, they also invest in projects with negative net present value, which causes the loss of investment value and the subsequent decrease in stock prices. Therefore, in order not to be eliminated by shareholders, managers try to cover non-optimal costs by reporting increased profits (Jensen, 1986) or by influence and accounting manipulations (Gowell and Tessi[4], 1998). For this reason, managers have a great tendency to use the increase in income of optional accrual items in order to report the increase in profit (Chang, Farce and Kim [5], 2005). Therefore, the reliability and usefulness of accruals is doubtful, because managers are able to adjust them according to their wishes (Hamidi, 2018).

    Free cash flow can be useful in evaluating the financial health of a company, because it discards all accounting assumptions in the income structure. A company's profit may be high and growing, but until the free cash is taken into account, it is not possible to know whether this profit is equal to the liquidity obtained for a company in a given year or not. Capital owners are ultimately interested in free cash, something that profit does not show (Maham, Fajarzadeh and Hosseini, 2015). According to Penman and Yehuda (2009), free cash flow can have informational content. Therefore, according to agency theory, it is likely that managers tend to spend extra money according to their own interests and put the interests of shareholders as the next priority. When profits are unstable, investors will need accounting information sources and free cash flow to make decisions..

    The equity valuation theory states that free cash flow cannot be related to stock returns (Dasgir and Sharifi, 2010) because it lacks added value (Habib [6], 2012; Zhang [7], 2000), free cash flow can only be related to stock returns under certain circumstances. According to the equity valuation model (Francis et al., 2004), investors are more interested in companies with stable profits. Therefore, in case of profit instability, investors draw their attention to factors such as free cash flow for valuation.

    The current research is based on accrual accounting and the lack of connection between free cash flow and stock returns may be conditioned by growth opportunities and profit quality. Therefore, this research examines the relationship between growth opportunities and profit stability in free cash flow valuation. The mentioned problem is shown in diagram number one.

    -3- Research Conceptual Model

    The purpose of this research is to examine the relationship between free cash flow in terms of profit stability and growth opportunities, with stock returns. Based on this, the conceptual model of the research is as follows. 1-4- Research Objectives 1) The purpose of this research is to examine the relationship between free cash flow in conditions of profit stability and stock returns. 2) The purpose of this research is to examine the relationship between free cash flow in conditions of growth opportunities and stock returns. (Tables and images are available in the main file)

    Abstract

     

    This paper examines empirically the effect of firm growth opportunities and earnings permanence on the market valuation of free cash flow. An accounting-based valuation framework is developed where stock returns are regressed on free cash flow interacted with growth opportunities & earnings permanence proxy, after controlling for book values, dividends, and current earnings. Required data from 89 companies over a ten year period is quarterly gathering. According to the result, it can in decisions affecting corporate managers and investors is to achieve an appropriate return in the Iranian capital market. The results indicate a significant positive relationship between free cash flow and return on equity with growth opportunities and when earnings are transitory.

  • Contents & References of Examining the relationship between growth opportunities and profit stability in free cash flow valuation

    List:

    Chapter 1.. 2

    1-1- Introduction. 3

    1-2- statement of the problem. 4

    1-3- conceptual model of research. 6

    1-4- Research objectives. 6

    1-5- Research questions. 7

    1-6- research hypotheses. 7

    1-7- Limitations of the research. 7

    1-7-1- Subject area. 7

    1-7-2- Spatial territory. 7

    1-7-3- Time domain. 8

    Definition of words and terms. 8

    The second chapter.. 9

    2-1- Introduction. 10

    2-2- Profit quality. 10

    2-2-1- Components of profit quality measurement. 14

    2-2-1-1- profit stability. 14

    2-2-1-2- Ability to predict profit. 15

    2-2-1-3- Timeliness of profit. 15

    2-2-1-4- Relevance of profit to share value. 16

    2-2-1-4- profit conservatism. 16

    2-3- Growth opportunities. 16

    2-3-1- Growth opportunities and capital structure. 17

    2-3-2- growth opportunities and dividends. 18

    2-3-3- Growth opportunities and ownership structure. 18

    2-4- Free cash flow. 19

    2-5- Regression analysis. 21

    2-6- Research records. 22

    2-6-1- Research abroad. 22

    2-6-2- Domestic research. 25

    2-7- Summary of research records. 28

    The third chapter. 30

    3-1- Introduction. 31

    3-2- Research method. 31

    3-2-1- The statistical population of the research. 31

    3-2-2- Statistical sample of the research. 32

    3-3- Data collection tools. 32

    3-4- Data and information analysis method. 33

    3-4-1- Data panel model. 34

    3-4-1-1- The advantage of consolidated data compared to time and cross-sectional series. 34

    3-4-1-2- Determining the estimation method in the panel data method. 35

    3-4-1-3-significance test of the individual effects of F Limer. 36

    3-4-1-4- Selecting the method for estimating the model. 37

    3-4-1-4-1- fixed effects method. 38

    3-4-1-4-2- random effects method. 38

    3-4-2- Classical statistical assumptions. 38

    3-4-3- Regression and correlation analysis. 41

    Chapter Four. 42

    4-1- Introduction. 43

    4-2- Statistical analysis of collected data. 43

    4-2-1- Statistical analysis of the growth opportunities hypothesis test. 43

    4-2-2- Statistical analysis of profit stability hypothesis test. 45

    The fifth chapter. 48

    5- 1- Introduction. 49

    5-2- A brief overview of the purpose, problem and how to work. 49

    5-3- Results and findings. 50

    5-4- Discussion, comparison and conclusion. 50

    5-5- Suggestions for future research. 52

    Sources.. 53

    Persian sources and sources. 54

    English sources and sources. 56

    Appendix.. 59

    English abstract. 64

     

    Source:

    Persian sources and sources

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    Pourhaidari, A., and Khaksari, M. (1387). Examining the determinants of the dividend policy in companies listed on the Tehran Stock Exchange. Development and Capital Journal, 1(2), 183-200.

    Thaghafi, Ali and Gholamreza Kurdestani (1383), investigation and explanation of the relationship between profit quality and market reaction to cash profit changes, Accounting and Auditing Reviews, 37, p. 56.

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    Hamidi, A. (1388). Examining the relationship between stock returns and errors in the evaluation of accruals in the Tehran Stock Exchange (Master's thesis), Qazvin: Imam Khomeini International University, taken from the database of Iran Science and Technology Research Institute.

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Examining the relationship between growth opportunities and profit stability in free cash flow valuation
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