Bias, accuracy and explainability of the Ohlson (1995) valuation model vs. the traditional dividend, abnormal earnings and free cash flow models: evidence from the Spanish stock market

Abstract

ABSTRACTIn this paper we compare the bias, accuracy and explainability of the Ohlson (1995) valuation model versus the traditional dividend, abnormal earnings and free cash flow models for a sample of Spanish listed firms over the period 2000–2008. The study aims to replicate the actual behaviour of financial practitioners when they estimate the value of a firm's shares. Our results document that the most accurate model is the Ohlson (1995) specification that considers the «other information» variable and intermediate persistence for both abnormal earnings and the «other information» variable. The abnormal earnings model also has a high performance, especially for the zero-growth case, confirming that a firm cannot increase abnormal earnings indefinitely. Finally, we have also assessed the relative performance of each model by computing future abnormal returns from a strategy based on the V/P ratio (intrinsic value divided by price). Our results provide evidence that most models are able, on average, of identifying overvalued and undervalued shares.