Comparison of the Residual Income and the Pricing - Multiples Equity Valuation Models

Abstract

The paper aims at analyzing the performance of two of the equity valuation models, the residual income (RIVM) and the pricing - multiples model. I test first how the residual income valuation model performs relative to the pricing - multiples model for a set of different value drivers and industries, second whether the performance of the different multiples increases when these are measured either with the mean, the median or the harmonic mean of the absolute prediction error and the signed prediction error. The pricing - multiples approach is in most cases a better predictor of market prices than the residual income valuation model. In addition, the harmonic mean yields to more reliable estimates of value for a set of different industries. Finally, there are some value drivers that are supposed to be more reliable than others in specific industries, but there isn’t any value driver that dominates all the industries.