Last sentence of LOS 27.b in Schweser FRA, pg. 175, states: “…If an investor fails to assign a lower weighting to the accrual component of the earnings, securities become mispriced.” What exactly is the weighting in this case? Conceptually, cash flows are better indicator of a firm’s state of health - and therefore minimizes mispricing during valuation. But let’s say if an analyst uses relative valuation, i.e. P/E then s/he is forced to use the accrual part of NI - what does weightage has to do with the valuation?
Well, the analyst could use adjusted P/E ratios if he/she so desired, I guess. You can’t adjust the financial statements for one firm and compare it against unadjusted firms.
I agree that it sounds better when ‘lower weighting’ = adjustment: If we restate the sentence to “…If an investor fails to adjust accrual component of the earnings, securities become mispriced.” But is that what they really mean - not sure whether the implication of the two phrases is similar.
good call. Simple concept here bad wording on their part