Equity Value as a Function of (Eps1, Eps2, Dps1, Bvps, Beta): Concepts and Realities
47 Pages Posted: 7 Apr 2015 Last revised: 16 Nov 2017
Date Written: June 14, 2015
This paper examines three basic equity valuation concepts: (i) Residual Income Valuation (RIV); (ii) in the spirit of Miller-Modigliani, the irrelevance of a firm’s dividend payout policy; (iii) betas/CAPM, to quantify risk and capitalization factors. As a first cut, results show that RIV, concept (i), lacks empirical support while in contrast concepts (ii) and (iii) hold up reasonably well. To address (ii) and (iii) we develop a model where earnings and earnings growth determine value. This model supplants RIV because of its greater intuitive appeal and empirical support. A linear function of eps1, eps2, and dps1 maps into stock prices, and the theory specifies the coefficients’ admissible magnitudes. Both the concepts of dividend payout irrelevance and risk (cost-of-equity per CAPM) restrict the coefficients. Bvps is value-irrelevant, in both the theory and the data. Our empirical analysis can be viewed as a case study; it considers S&P500 firms at two points in time, and the data was hand-collected in real time from a public website (Yahoo!Finance). The two points in time differ by about a year. This scheme ensures perfectly synchronized data, and it usefully provides not only consensus forecasts but also real time betas. Overall, the paper contributes by developing valuation concepts and by showing how these can be evaluated empirically.
Keywords: Valuation, RIV, OJ, earnings capitalization
JEL Classification: M41
Suggested Citation: Suggested Citation