The Incremental Role of Revenue in Valuing Firms
Posted: 6 Nov 2005
Date Written: October 4, 2005
This study examines the role of revenue in valuing firms beyond earnings and investigates whether the ability of revenue to explain stock returns (1) is pervasive or limited to certain situations in which earnings may be less informative, (2) is sensitive to nonlinearity in the relation between returns and earnings, and (3) has changed over time. Our analysis indicates that revenue information is useful both as a summary measure of a firm's performance for valuation purposes and in conveying new information to the market, after controlling for earnings information. These results are not driven by technology firms, firms incurring losses, or firm-quarters with extreme earnings news - situations in which earnings information may be less useful or persistent, or by model misspecification due to nonlinearity in the returns-earnings relation. Further, we find significant nonlinearity in the relation between returns and both earnings and revenue. While the ability of revenue and earnings to summarize information on firm performance is stable across time, the new information conveyed by earnings has declined while the ability of revenue to incrementally convey new information has not diminished.
Keywords: Value relevance, Revenue, Nonlinearity, Longitudinal change in value relevance
JEL Classification: G12, M41
Suggested Citation: Suggested Citation