The Role of Future Earnings and Dividends in Security Valuation: A Reexamination of the Fundamental Links
Posted: 10 Jun 1996
Date Written: May 1996
This paper examines the usefulness of future earnings and future dividends in security valuation. Our tests involve calculating intrinsic value estimates for Ohlson's (1995) earnings capitalization model and the traditional dividend discount model, and then using these intrinsic value estimates to explain cross-sectional variation in observed prices.Cross-sectional regression results are inconclusive when both positive and negative earnings realizations are used in calculating the earnings capitalization model intrinsic value estimate. Both the earnings capitalization model and dividend discount model explain a significant portion of observed stock price variation, but neither clearly dominates the other. However, when negative earnings realizations are excluded, the earnings intrinsic value estimates clearly dominate the dividend intrinsic value estimates in explaining observed prices. Decomposition analysis suggests that the advantage of the earnings capitalization model over the dividend discount model is due to the reinvested earnings component of aggregate future earnings.
JEL Classification: G12, M41, G35
Suggested Citation: Suggested Citation