The Implications of Firms' Investment Opportunities for the Valuation of Cash Flows from Investing Activities

This paper examines the market valuation of cash flows from investing (CFI) activities in the presence of investment opportunities. The market valuation of investing cash flows is hypothesized to be larger when a firm possesses a relatively larger amount of positive net present value investment opportunities. Using a dichotomous growth classification, the investing cash flows of high-growth firms are found to have significant explanatory power for unexpected security returns while the investing cash flows of low-growth firms are valued consistent with "overinvestments" by firms' managers. Additional tests suggest that the return-CFI relation is affected by the level of investment opportunities.