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Ratio Analysis and Equity Valuation: From Research to Practice

Author

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  • Doron Nissim

    (Columbia University)

  • Stephen H. Penman

    (Columbia University)

Abstract

Financial statement analysis has traditionally been seen as part of thefundamental analysis required for equity valuation. But the analysis has typicallybeen ad hoc. Drawing on recent research on accounting-based valuation, this paperoutlines a financial statement analysis for use in equity valuation. Standardprofitability analysis is incorporated, and extended, and is complemented with ananalysis of growth. An analysis of operating activities is distinguished from theanalysis of financing activities. The perspective is one of forecasting payoffs to equities. So financial statement analysis is presented as a matter of pro formaanalysis of the future, with forecasted ratios viewed as building blocks offorecasts of payoffs. The analysis of current financial statements is then seen asa matter of identifying current ratios as predictors of the future ratios thatdetermine equity payoffs. The financial statement analysis is hierarchical, withratios lower in the ordering identified as finer information about those higher up.To provide historical benchmarks for forecasting, typical values for ratios aredocumented for the period 1963–1999, along with their cross-sectionalvariation and correlation. And, again with a view to forecasting, the time seriesbehavior of many of the ratios is also described and their typical “long-run,steady-state” levels are documented.

Suggested Citation

  • Doron Nissim & Stephen H. Penman, 2001. "Ratio Analysis and Equity Valuation: From Research to Practice," Review of Accounting Studies, Springer, vol. 6(1), pages 109-154, March.
    • Handle: RePEc:spr:reaccs:v:6:y:2001:i:1:d:10.1023_a:1011338221623
    DOI: 10.1023/A:1011338221623
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    2. Patricia M. Dechow & Richard G. Sloan & Mark T. Soliman, 2004. "Implied Equity Duration: A New Measure of Equity Risk," Review of Accounting Studies, Springer, vol. 9(2), pages 197-228, June.
    3. Adam Esplin & Max Hewitt & Marlene Plumlee & Teri Lombardi Yohn, 2014. "Disaggregating operating and financial activities: implications for forecasts of profitability," Review of Accounting Studies, Springer, vol. 19(1), pages 328-362, March.
    4. Dennis Chambers & Thomas J. Linsmeier & Catherine Shakespeare & Theodore Sougiannis, 2007. "An evaluation of SFAS No. 130 comprehensive income disclosures," Review of Accounting Studies, Springer, vol. 12(4), pages 557-593, December.
    5. 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.
    6. Eli Amir & Itay Kama & Joshua Livnat, 2011. "Conditional versus unconditional persistence of RNOA components: implications for valuation," Review of Accounting Studies, Springer, vol. 16(2), pages 302-327, June.
    7. 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.
    8. Elena Rond'os-Casas & Germ`a Coenders & Miquel Carreras-Sim'o & N'uria Arimany-Serrat, 2025. "The use of financial and sustainability ratios to map a sector. An approach using compositional data," Papers 2509.06468, arXiv.org.
    9. Matthew Kubic, 2025. "The benefits of article 11 pro forma disclosure," Review of Accounting Studies, Springer, vol. 30(3), pages 2768-2821, September.
    10. Peter Easton & Jinhan Pae, 2004. "Accounting Conservatism and the Relation Between Returns and Accounting Data," Review of Accounting Studies, Springer, vol. 9(4), pages 495-521, December.
    11. Stephen H. Penman & Nir Yehuda, 2009. "The pricing of earnings and cash flows and an affirmation of accrual accounting," Review of Accounting Studies, Springer, vol. 14(4), pages 453-479, December.
    12. Asher Curtis & Melissa F. Lewis-Western & Sara Toynbee, 2015. "Historical cost measurement and the use of DuPont analysis by market participants," Review of Accounting Studies, Springer, vol. 20(3), pages 1210-1245, September.
    13. Maria Correia & Scott Richardson & İrem Tuna, 2012. "Value investing in credit markets," Review of Accounting Studies, Springer, vol. 17(3), pages 572-609, September.
    14. Marty Gosman & Trish Kelly & Per Olsson & Terry Warfield, 2004. "The Profitability and Pricing of Major Customers," Review of Accounting Studies, Springer, vol. 9(1), pages 117-139, March.
    15. Doron Nissim & Stephen H. Penman, 2003. "Financial Statement Analysis of Leverage and How It Informs About Profitability and Price-to-Book Ratios," Review of Accounting Studies, Springer, vol. 8(4), pages 531-560, December.
    16. Doron Nissim, 2013. "Relative valuation of U.S. insurance companies," Review of Accounting Studies, Springer, vol. 18(2), pages 324-359, June.
    17. Paul Healy & George Serafeim & Suraj Srinivasan & Gwen Yu, 2014. "Market competition, earnings management, and persistence in accounting profitability around the world," Review of Accounting Studies, Springer, vol. 19(4), pages 1281-1308, December.
    18. Masako Darrough & Jianming Ye, 2007. "Valuation of loss firms in a knowledge-based economy," Review of Accounting Studies, Springer, vol. 12(1), pages 61-93, March.
    19. Derek K. Oler, 2008. "Does acquirer cash level predict post-acquisition returns?," Review of Accounting Studies, Springer, vol. 13(4), pages 479-511, December.
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    21. Eli Amir & Eti Einhorn & Itay Kama, 2014. "The role of accounting disaggregation in detecting and mitigating earnings management," Review of Accounting Studies, Springer, vol. 19(1), pages 43-68, March.
    22. Patricia M. Fairfield, 2006. "Discussion of “The persistence of earnings and cash flows and the role of special items: Implications for the accrual anomaly”," Review of Accounting Studies, Springer, vol. 11(2), pages 297-303, September.

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