A Comparison of Dividend, Cash Flow, and Earnings Approaches to Equity Valuation PDF Download
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Author: Stephen H. Penman
Publisher:
ISBN:
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Languages : en
Pages : 0
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Book Description
Standard formulas for valuing the equity of going concerns require prediction of payoffs "to infinity" but practical analysis requires that they be predicted over finite horizons. This truncation inevitably involves (often troublesome) "terminal value" calculations. This paper contrasts dividend discount techniques, discounted cash flow analysis, and techniques based on accrual earnings when applied to a finite-horizon valuation. Valuations based on average ex-post payoffs over various horizons, with and without terminal value calculations, are compared with (ex-ante) market prices to give an indication of the error introduced by each technique in truncating the horizon. Comparisons of these errors show that accrual earnings techniques dominate free cash flow and dividend discounting approaches. Further, the relevant accounting features of techniques that make them less than ideal for finite horizon analysis are discovered. Conditions where a given technique requires particularly long forecasting horizons are identified and the performance of the alternative techniques under those conditions is examined.
Author: Stephen H. Penman
Publisher:
ISBN:
Category :
Languages : en
Pages : 0
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Book Description
Standard formulas for valuing the equity of going concerns require prediction of payoffs "to infinity" but practical analysis requires that they be predicted over finite horizons. This truncation inevitably involves (often troublesome) "terminal value" calculations. This paper contrasts dividend discount techniques, discounted cash flow analysis, and techniques based on accrual earnings when applied to a finite-horizon valuation. Valuations based on average ex-post payoffs over various horizons, with and without terminal value calculations, are compared with (ex-ante) market prices to give an indication of the error introduced by each technique in truncating the horizon. Comparisons of these errors show that accrual earnings techniques dominate free cash flow and dividend discounting approaches. Further, the relevant accounting features of techniques that make them less than ideal for finite horizon analysis are discovered. Conditions where a given technique requires particularly long forecasting horizons are identified and the performance of the alternative techniques under those conditions is examined.
Author: Lucie Courteau
Publisher:
ISBN:
Category :
Languages : en
Pages : 52
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Book Description
Recently, Penman and Sougiannis (1998) and Francis, Olsson and Oswald (1999) compared the bias and accuracy of the dividend discount model (DDM), discounted cash flow model (DCF), and Edwards-Bell-Ohlson residual income model (RIM) in explaining the relation between value estimates and observed stock prices. Both studies report that, with non price-based terminal values, RIM outperforms DCF and DDM. Our primary research objective is to explore whether, over a five-year valuation horizon, DDM, DCF and RIM are empirically equivalent when Penman's (1998) theoretically quot;idealquot; terminal value expressions are employed in each model. Using Value Line terminal stock price forecasts at the horizon to proxy for such values, we find empirical support for the prediction of equivalence between these three price-based valuation models.Our secondary research objective is to demonstrate that, within each class of the DCF and RIM valuation models, the model that employs Value Line forecasted price in the terminal value expression will generate the lowest pricing errors, compared to models that employ non price-based terminal value under an arbitrary growth assumption. Results indicate that, for both DCF and RIM, price-based valuation models outperform the corresponding non price-based models by a wide margin. We also revisit the issue of the apparent superiority of RIM, and find that this result does not hold in a level playing field where an approximation of ideal terminal values is employed. In fact, the price-based RIM model is marginally outperformed by the price-based DCF and DDM models, in terms of pricing errors as well as its ability to explain current market price.
Author: Aswath Damodaran
Publisher: Now Publishers Inc
ISBN: 1601980140
Category : Business & Economics
Languages : en
Pages : 102
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Book Description
Valuation lies at the heart of much of what we do in finance, whether it is the study of market efficiency and questions about corporate governance or the comparison of different investment decision rules in capital budgeting. In this paper, we consider the theory and evidence on valuation approaches. We begin by surveying the literature on discounted cash flow valuation models, ranging from the first mentions of the dividend discount model to value stocks to the use of excess return models in more recent years. In the second part of the paper, we examine relative valuation models and, in particular, the use of multiples and comparables in valuation and evaluate whether relative valuation models yield more or less precise estimates of value than discounted cash flow models. In the final part of the paper, we set the stage for further research in valuation by noting the estimation challenges we face as companies globalize and become exposed to risk in multiple countries.
Author:
Publisher:
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Category :
Languages : en
Pages : 45
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Book Description
Author: Aswath Damodaran
Publisher: John Wiley & Sons
ISBN: 9780471414902
Category : Business & Economics
Languages : en
Pages : 1014
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Book Description
Valuation is a topic that is extensively covered in business degree programs throughout the country. Damodaran's revisions to "Investment Valuation" are an addition to the needs of these programs.
Author: Rawley Thomas
Publisher: John Wiley & Sons
ISBN: 1118283244
Category : Business & Economics
Languages : en
Pages : 283
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Book Description
A must-read book for investors who prefer to pick stocks based on cash flow facts, not on media hype and fiction How to Pick a Stock is written for the contrarian investor who wants an investing method that is based on cash flow facts, not on media hype and speculative impulse. This book combines an accessible presentation of a contrarian investment model and the ValuFocus tool that offers a highly studious, detailed explanation of understanding a company's true intrinsic value. If you can calculate a company's intrinsic value on the basis of knowing if the market is currently under, fairly, or over pricing its stock, then it is possible to invest wisely in the stock market. Investors who want to buy undervalued stocks, or sell (short) overvalued ones will find this book immensely useful. The ValuFocus investing tool calculates the intrinsic value of every company in their database automatically. Thus, an individual investor can become an "A" student of a modeling process, or can go right ahead in using this tool to pick stocks and manage their own portfolio. Additionally, this book helps to develop an enhanced framework to fundamental equity valuation. Contains the ValuFocus tool for calculating the intrinsic value of every company in the LCRT Nucleus database Offers specific and innovative valuation techniques of practicing professionals for individuals to use in picking stocks long-term Highlights the most state-of-the-art approaches to unconventional stock-picking for investors and corporate finance professionals Offering encouragement to individual investors by outlining a model that delivers satisfying returns, How to Pick a Stock is especially useful for those who are patient and believe in longer-term investing horizons.
Author: Megha Agarwal
Publisher:
ISBN:
Category :
Languages : en
Pages : 11
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Book Description
The research paper is an effort to compare the earnings based and cash flow based methods of valuation of an enterprise. The theoretically equivalent methods based on either earnings such as Residual Earnings Model (REM), Abnormal Earnings Growth Model (AEGM), Residual Operating Income Method (ReOIM), Abnormal Operating Income Growth Model (AOIGM) and its extensions multipliers such as Price/Earnings Ratio, Price/Book Value Ratio; or cash flow based models such as Dividend Valuation Method (DVM) and Free Cash Flow method (FCFM) all provide different estimates of valuation of the Indian giant corporate Reliance India Limited (RIL). An ex-post analysis of published accounting and financial data for four financial years from 2008-09 to 2011-12 has been conducted. A comparison of these valuation estimates with the actual market capitalization of the company shows that the complex accounting based model AOIGM provides closest forecasts. These different estimates may be derived due to inconsistencies in discount rate, growth rates and the other forecasted variables. Although inputs for earnings based models may be available to the investor and analysts through published statements, precise estimation of free cash flows may be better undertaken by the internal management. The estimation of value from more stable parameters as Residual operating income and Residual Net Operating Assets could be considered superior to the valuations from more volatile return on equity.
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Languages : en
Pages :
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Book Description
Standard equity valuation approaches (i.e., DDM, RIM, and DCF model) are derived under the assumption of ideal conditions, such as infinite payoffs and clean surplus accounting. Because these conditions are hardly ever met, we extend the standard approaches, based on the fundamental principle of financial statement articulation. The extended models are then tested empirically by employing two sets of forecasts: (1) analyst forecasts provided by Value Line and (2) forecasts generated by cross-sectional regression models. The main result is that our extended models yield considerably smaller valuation errors. Moreover, by construction, identical value estimates are obtained across the extended models. By reestablishing empirical equivalence under non-ideal conditions, our approach provides a benchmark that enables us to quantify the errors resulting from individual deviations from ideal conditions, and thus, to analyze the robustness of the standard approaches. Finally, by providing a level playing field for the different valuation approaches, our findings have implications for other empirical settings, for example, estimating the implied cost of capital. -- Dirty Surplus ; Terminal Value ; Steady-State ; Valuation Error
Author: Stephen H. Penman
Publisher:
ISBN:
Category :
Languages : en
Pages : 23
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Book Description
A claim is commonly made that cash and accrual accounting methods for valuing equities must always yield equivalent valuations. A recent paper by Lundholm and O'Keefe (Contemporary Accounting Research, Summer, 2001), for example, claims that, because of this equivalence, there is nothing to be learned from empirical comparison of valuation models. So they dismiss recent research that has shown that accrual accounting residual income models and earnings capitalization models perform, over a range of conditions, better than cash flow or dividend discount models. This paper demonstrates, with examples, that the claim is misquided. Practice inevitably involves forecasting over finite,truncated horizons and the accounting specified in a model - cash versus accrual accounting in particular - is pertinent to valuation with finite horizon forecasting. Indeed, the issue of choosing a valuation model is an issue of specifying pro forma accounting, and so, for finite horizon forecasts, one cannot be indifferent to the accounting.
Author: Stephen Penman
Publisher: Columbia University Press
ISBN: 0231521855
Category : Business & Economics
Languages : en
Pages : 265
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Book Description
Accounting for Value teaches investors and analysts how to handle accounting in evaluating equity investments. The book's novel approach shows that valuation and accounting are much the same: valuation is actually a matter of accounting for value. Laying aside many of the tools of modern finance the cost-of-capital, the CAPM, and discounted cash flow analysis Stephen Penman returns to the common-sense principles that have long guided fundamental investing: price is what you pay but value is what you get; the risk in investing is the risk of paying too much; anchor on what you know rather than speculation; and beware of paying too much for speculative growth. Penman puts these ideas in touch with the quantification supplied by accounting, producing practical tools for the intelligent investor. Accounting for value provides protection from paying too much for a stock and clues the investor in to the likely return from buying growth. Strikingly, the analysis finesses the need to calculate a "cost-of-capital," which often frustrates the application of modern valuation techniques. Accounting for value recasts "value" versus "growth" investing and explains such curiosities as why earnings-to-price and book-to-price ratios predict stock returns. By the end of the book, Penman has the intelligent investor thinking like an intelligent accountant, better equipped to handle the bubbles and crashes of our time. For accounting regulators, Penman also prescribes a formula for intelligent accounting reform, engaging with such controversial issues as fair value accounting.
