An article in BusinessWeek described how Bob Olstein, a successful stock analyst, predicts that the prices of stocks issued by firms that “engage in aggressive accounting practices” will go down, stating that other “investors have unrealistic expectations of the earnings potential”. He cites Mattel as an example by noting that big changes in net receivables, inventories, and deferred income taxes, as well as foreign currency translation gains that produced no cash, accounted for most of Mattel’s earnings growth. The company’s debt also jumped “from $440 million to $630 million in about two years”
Required
(a) Explain how the statement of cash flows, especially if prepared under the indirect format can be used to identify “quality of earnings” and “earnings persistence” problems.
(b) Specifically describe how the information mentioned above about Mattel was used to indicate these kinds of problems.
(c) Do you think that it is possible to identify over- and undervalued stocks by identifying firms that use aggressive accounting practices?