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Expected EPS and EPS Growth as Determinantsof Value

Author

Listed:
  • James A. Ohlson

    (Arizona State University)

  • Beate E. Juettner-Nauroth

    (Johannes Gutenberg-University)

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.

Suggested Citation

  • James A. Ohlson & Beate E. Juettner-Nauroth, 2005. "Expected EPS and EPS Growth as Determinantsof Value," Review of Accounting Studies, Springer, vol. 10(2), pages 349-365, September.
    • Handle: RePEc:spr:reaccs:v:10:y:2005:i:2:d:10.1007_s11142-005-1535-3
    DOI: 10.1007/s11142-005-1535-3
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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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