On the Relevance of Earnings Components in Valuation and Forecasting

31 Pages Posted: 18 Jan 2013

Date Written: December 1, 2011

Abstract

This paper articulates the links between relevance of an earnings component in forecasting (abnormal) earnings and its relevance in valuation in a nonlinear framework. The analysis shows that forecasting relevance does not imply valuation relevance even though valuation irrelevance is implied by forecasting irrelevance. Firstly, I consider an accounting information system where earnings components "add up" to a fully informative earnings number. Secondly, I analyze two accounting systems where a "core" earnings component is the relevant earnings construct for valuation and the second earnings component is irrelevant but may be predictable and relevant in forecasting other accounting items. I find that dividend displacement effect on earnings and the dynamics of individual earnings components are critical in this analysis.

Keywords: valuation, forecasting, earnings components, residual income valuation model

JEL Classification: G17, G32, M41

Suggested Citation

Wang, Pengguo, On the Relevance of Earnings Components in Valuation and Forecasting (December 1, 2011). Available at SSRN: https://ssrn.com/abstract=2201604 or http://dx.doi.org/10.2139/ssrn.2201604

Pengguo Wang (Contact Author)

Xfi, University of Exeter ( email )

Streatham Court
Exeter, EX4 4PU
United Kingdom

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