Estimating Firm-specific Long-term Growth Rate and Cost of Capital (original) (raw)
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The value premium is well established in empirical asset pricing, but to date there is little understanding as to its fundamental drivers. We use a stochastic earnings valuation model to establish a direct link between the volatility of future earnings growth and firm value. We illustrate that risky earnings growth affects growth and value firms differently. We provide empirical evidence that the volatility of future earnings growth is a significant determinant of the value premium. Using data on individual firms and characteristic-sorted test portfolios, we also find that earnings growth volatility is significant in explaining the cross-sectional variation of stock returns. Our findings imply that the value premium is the rational consequence of accounting for risky earnings growth in the firm valuation process.
Journal of Business Finance & Accounting, 2011
We compare the valuation accuracy of the equity value estimates inferred from empirical implementations of the abnormal earnings growth model (Ohlson and Juettner-Nauroth 2005; the OJ estimates) with the residual income model (Ohlson 1995; the RIV estimates). We find that the OJ estimates generally underperform the RIV estimates. Increasing the forecast horizon for the OJ estimates from two to five years significantly improves their valuation accuracy. However, relative to the RIV estimates, the valuation accuracy of the OJ estimates remains lower even using a five-year forecast horizon. Finally, we compare predicted accounting profitability with actual accounting profitability and find that the lower valuation accuracy of the OJ estimates is attributable to the empirical assumptions regarding future earnings growth beyond the forecast horizon.
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In terms of corporate valuation, the frequently used heuristics are Price Earnings or Price Earnings to Growth ratios. The development of a valuation model of type Abnormal Earnings Growth Model including modeling of expected rents evolution, conditions compatible with perfect competition, allows us to propose a testable relationship between market value of share, expected earnings per share in a year, its rate of growth in short term and a set of accounting variables composing a synthetic indicator of growth of company. Our results show that (1) expected increase in earnings per share are significantly associated with stock prices for developed countries, (2) but, the persistence of its effects is limited for emerging countries, (3) when the dynamics of growth are more complex, inclusion of synthetic variable of can make a significant correction term (4) and the implied cost of capital is significantly higher for emerging countries than for developed countries.
Comparison of the Residual Income and the Pricing - Multiples Equity Valuation Models
International Journal of Economics and Business Administration
The paper aims at analyzing the performance of two of the equity valuation models, the residual income (RIVM) and the pricing-multiples model. I test first how the residual income valuation model performs relative to the pricing-multiples model for a set of different value drivers and industries, second whether the performance of the different multiples increases when these are measured either with the mean, the median or the harmonic mean of the absolute prediction error and the signed prediction error. The pricing-multiples approach is in most cases a better predictor of market prices than the residual income valuation model. In addition, the harmonic mean yields to more reliable estimates of value for a set of different industries. Finally, there are some value drivers that are supposed to be more reliable than others in specific industries, but there isn't any value driver that dominates all the industries. 2 Easton (1999) refers to other, more detailed studies concerning the relation between prices and accounting data, such as those of Feltham and Ohlson (1995), Basu (1997) and Zhang (1999). These three papers examine this relation when a firm's policies are conservative. Comparison of the Residual Income and the Pricing-Multiples Equity Valuation Models 90 as value estimates derived from this model track intrinsic value better than dividends, earnings or book value. Liu, Nissim and Thomas (2002a) provide a more complete comparison of the relative and absolute performance of numerous multiples. They have considered multiples based on diverse measures, such as accrual flows (earnings to price, sales to price), accrual stocks (book to price), cash flows (EBITDA to price, operating cash flow to price), forward-looking data (one and two year ahead earnings forecasts to price), the RIVM (V/P following Lee and Swaminathan (1999)). The first three measures are based on historical data while on the contrary, the remaining two on forecasts. Moreover, all the multiples have been computed with the harmonic mean. Consistent with Lee and Swaminathan (1999), they observe that multiples based on the RIVM perform better than those based on historical data. However, they provide additional evidence that forward-looking earnings outperform the residual income based multiples, contradicting the conclusions of Lee and Swaminathan (1999). Finally, they go further, suggesting that among the multiples based on historical data, earnings are the best value estimates whereas all the others perform poorly.
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American J. of Finance and Accounting
This paper integrates the long-run covariance between aggregate consumption and firm earnings into the stock valuation process. After assuming that firms adjust their dividend payments toward a target dividend payout ratio, we use the intertemporal framework of the consumption capital asset pricing model (CCAPM) to explore the effect of systematic earnings risks on intrinsic stock values. Our main results show that the equilibrium price of a stock is positively related to its long-run earnings growth rate, and negatively related to its earnings-consumption beta, obtained from its long-run covariance between earnings growth and aggregate consumption growth. This suggests that long-run risk measured with earnings affects the theoretical value of a firm. Overall, our work suggests that the long-run concept of risk, using accounting earnings, represents an appropriate parameter for estimating the equity value of a firm. He has published several papers in refereed scientific journals.
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The Journal of Finance, 1968
Chicago. We are indebted to Paul Cootner for helpfal comments. 1. A number of studies of anticipations data have been collected in two National Bureau Volumes [12] and [13]. Some more recent work on the assessment of expectations or forecasts has been done by Zarnowitz [16]. 2. The classic theoretical statement of the anticipations view of the determination of share valuation may be found in J. B. Williams [15]. This position is also adopted in the standard textbook in the field [3]. The emphasis on the importance of earnings growth may also be found in [4], [5], and [19]. 3. One of the few attempts to conduct a study of this type was made by the Continental Illinois Bank and Trust Company of Chicago [l] in 1963. The bank collected a sample of earnings estimates one year in advance from three investment firms. An analysis of these projections revealed that the financial firms tended to overestimate earnings and that overall quality of the estimates tended to be poor. 4. The 185 companies for which the growth-rate estimates were made tended to be the large corporations in whose securities investment interest is centered. This selection was made on the basis of availability of data and was not chosen as a random sample.
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