Expected EPS and EPS growth as determinantsof value

James Arvid Ohlson, Beate E. Juettner-Nauroth

Research output: Journal article publicationJournal articleAcademic researchpeer-review

505 Citations (Scopus)

Abstract

This paper develops a parsimonious model relating a firm's price per share to, (i), next year expected earnings per share (or 12 months forward eps), (ii), short-term growth (FY-2 versus FY- l) in eps, (iii), long-term (asymptotic) growth in eps, and, (iv), cost-of-equity capital. The model assumes that the present value of dividends per share (dps) determines price, but it does not restrict how the dps-sequence is expected to evolve. All of these aspects of the model contrast sharply with the standard (Gordon/Williams) text-book approach, which equates the growth rates of expected eps and dps and fixes the growth rate and the payout rate. Though the constant growth model arises as a peculiar special case, the analysis in this paper rests on more general principles, including dividend policy irrelevancy. A second key result inverts the valuation formula to show how one expresses cost-of-capital as a function of the forward eps to price ratio and the two measures of growth in expected eps. This expression generalizes the text-book equation in which cost-of-capital equals the dps-yield plus the growth in expected eps.
Original languageEnglish
Pages (from-to)349-365
Number of pages17
JournalReview of Accounting Studies
Volume10
Issue number2-3
DOIs
Publication statusPublished - 1 Jun 2005
Externally publishedYes

Keywords

  • Devidend policy
  • EPS
  • EPS growth
  • Equity valuation

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting(all)

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