On accounting-based valuation formulae

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55 Citations (Scopus)

Abstract

This paper considers accounting-based valuation formulae. Its initial focus is on two problems related to residual income valuation (RIV). First, insofar valuation depends on theresent value of expected dividends per share, applying RIV requires clean surplus accounting on a per share basis. Awkwardly, equity transactions that change the number of shares outstanding generally imply eps ≠ Δ bvps∈-∈dps. A clean surplus equality holds only if one "re-conceptualizes" either end-of-period bvps or eps as a forced "plug". Second, one cannot circumvent the per share issue by evaluating RIV on a total dollar value basis unless one introduces relatively subtle MM-type restrictions. In light of RIV's unsatisfactory aspects, the paper proposes an alternative to RIV. This new approach maintains a strict eps-focus. It derives by replacing bvpstin RIV with epst +1capitalized (i.e. divided by r). One obtains a formula such that the current market price equals next-period expected earnings capitalized plus the present value of expected abnormal earnings growth, referred to as AEG. A number of propositions then demonstrate the advantages of the AEG approach as compared to RIV. These results follow because epst+1capitalized generally approximates market price better than bvpst.
Original languageEnglish
Pages (from-to)323-347
Number of pages25
JournalReview of Accounting Studies
Volume10
Issue number2-3
DOIs
Publication statusPublished - 1 Jun 2005
Externally publishedYes

Keywords

  • Dividend policy
  • EPS
  • EPS growth
  • Equity valuation

ASJC Scopus subject areas

  • Accounting
  • Business, Management and Accounting(all)

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