The Valuation Accuracy of Equity Value Estimates Inferred from Conventional Empirical Implementations of the Abnormal Earnings Growth Model: US Evidence

Abstract

We compare the valuation accuracy of the equity value estimates inferred from empirical implementations of the abnormal earnings growth model (Ohlson and Juettner-Nauroth 2005; the OJ estimates) with the residual income model (Ohlson 1995; the RIV estimates). We find that the OJ estimates generally underperform the RIV estimates. Increasing the forecast horizon for the OJ estimates from two to five years significantly improves their valuation accuracy. However, relative to the RIV estimates, the valuation accuracy of the OJ estimates remains lower even using a five-year forecast horizon. Finally, we compare predicted accounting profitability with actual accounting profitability and find that the lower valuation accuracy of the OJ estimates is attributable to the empirical assumptions regarding future earnings growth beyond the forecast horizon.

Keywords: abnormal earnings growth, equity valuation, residual income, valuation accuracy