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On Accounting-Based Valuation Formulae

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  • James A. Ohlson

    (Arizona State University)

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 bvps t in RIV with eps t +1 capitalized (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 eps t+1 capitalized generally approximates market price better than bvps t .

Suggested Citation

  • James A. Ohlson, 2005. "On Accounting-Based Valuation Formulae," Review of Accounting Studies, Springer, vol. 10(2), pages 323-347, September.
    • Handle: RePEc:spr:reaccs:v:10:y:2005:i:2:d:10.1007_s11142-005-1534-4
    DOI: 10.1007/s11142-005-1534-4
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    References listed on IDEAS

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    1. James A. Ohlson, 2001. "Earnings, Book Values, and Dividends in Equity Valuation: An Empirical Perspective," Contemporary Accounting Research, John Wiley & Sons, vol. 18(1), pages 107-120, March.
    2. Peter Easton & Gary Taylor & Pervin Shroff & Theodore Sougiannis, 2002. "Using Forecasts of Earnings to Simultaneously Estimate Growth and the Rate of Return on Equity Investment," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 40(3), pages 657-676, June.
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    Cited by:

    1. Cheng Lai, 2015. "Growth in residual income, short and long term, in the OJ model," Review of Accounting Studies, Springer, vol. 20(4), pages 1287-1296, December.
    2. Colin D. B. Clubb, 2013. "Information dynamics, dividend displacement, conservatism, and earnings measurement: a development of the Ohlson (1995) valuation framework," Review of Accounting Studies, Springer, vol. 18(2), pages 360-385, June.
    3. Nowak, Arne & Fahling, Ernst, 2015. "The Influence of R&D Intensity on the Performance and Application of Fundamental and Relative Equity Valuation Methods – Part I," ISM Research Journal, International School of Management (ISM), Dortmund, vol. 2(1), pages 19-35.
    4. Steven J. Monahan, 2011. "Discussion of “Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth”," Review of Accounting Studies, Springer, vol. 16(3), pages 458-463, September.

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    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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