Residual Income Valuation Model Research Articles

Can a Hybrid Method Improve Equity Valuation? Empirical Applications of Ohlson and Johannesson (2016)

We investigate whether combining the two principal valuation techniques – a price multiple model and a discounted model – can improve the quality of equity valuation. Specifically, we empirically implement the theoretical valuation model in Ohlson and Johannesson (2016), which we refer to as the OHJO model (or OHJO), as a hybrid of a price multiple model and a discounted model, and develop a novel way to estimate the model’s unique parameter – the normal forward P/E ratio. We find that our implementation produces intrinsic values that are more accurate and generally less biased, and that are better at explaining stock prices, than popular discounted models such as the Residual Income Valuation Model (RIV) and the Ohlson-Juettner Model (OJ), as well as price multiple models. OHJO’s superior valuation performance is robust in subsamples, and is more pronounced for slow growing, less risky, and larger firms. In addition, the implied cost of equity estimated from OHJO captures systematic risk and information asymmetry better than that from RIV and OJ. These results demonstrate the usefulness of a hybrid method for equity valuation and support the empirical validity of OHJO.

Behavioral Timing, Valuation and Postissue Performance of UK Initial Public Offerings

ABSTRACTUsing a sample of 1,926 UK initial public offerings (IPOs) launched from 1987 to 2007, this study introduces a new angle on testing the behavioral timing hypothesis in the context of UK IPOs via investigating relationships between the magnitude of IPOs misvaluation and postissue stock price and operating performance. IPO misvaluation is measured using (i) an intrinsic value of the firm estimated using residual income valuation model and (ii) intensity of IPO issuance activity. The findings show that stock price and operating underperformance in the postissue are directly linked to the degree of IPOs' misvaluation. Specifically, the stock price and operating performance are found to be significantly and robustly different between hot markets IPOs and cold market IPOs 3 years postissue. We also show that overvalued IPOs have lower long-run stock returns, but outperforming operating performance, than undervalued IPOs do. Our findings are broadly consistent with the behavioral explanations of the poor stock price and operating performance, supporting the U.S. results of Purnanandam and Swaminathan [2004] and Loughran and Ritter [2000].

Valuation Role of Accounting Information in Profit and Loss Firms

Purpose of the research: This study identifiesthe most important value-relevant factor across profit and loss companies listed on the Korean Securities Exchange over the period 2000 to 2015.Weaim to improve understanding of the role of accounting information provided by financial statements in firm value across companies. Materials and methods: We use the residual income valuation model of Ohlson (1995). Results: The impact of accounting information on enterprise value is significantly different across profit and loss companies. We believe that this phenomenon occurs because of the assumption of linear information dynamics in theresidual income model. These findings show that accounting information of profitable companies is likely to reflect on the future firm value; however, accounting information of loss companies tends to provide no such information to financial markets.

Empirical estimation of the Residual Income Valuation Model: Profit-Making vs. Loss-Making firms

Empirical estimation of the Residual Income Valuation Model: Profit-Making vs. Loss-Making firms Walid Saleh Abstract This paper tests the empirical performance of different specifications of the residual income valuation model based upon the inflation-adjusted model of Gregory, Saleh, and Tucker (2005) that is consistent with the Walker's (1997, p 354) suggestion that historical cost accounting versions of the model be abandoned in favor of one based on deprival values. Overall, the paper concludes that the Ohlson (1995) specification appears to be the best model that explains stock prices relative to other specifications used in this paper. Full Text: PDF DOI: 10.15640/jfbm.v5n2a2

Who’s a major? A novel approach to peer group selection: Empirical evidence from oil and gas companies

AbstractThis study presents a novel approach to selecting comparable companies in equity valuation. While valuation multiples is probably the most common valuation method in practice, discounted cash flow and residual income valuation models are advocated by academics. A key aspect in valuation by multiples is peer group selection. In this paper, we examine the usefulness of econometric techniques in peer-group selection for the largest companies in the international oil and gas sector. Using Chow tests, we are able to identify firms with similar relationships between valuation multiples and relevant value drivers. These results of our study suggest that analysts and investors should, when carrying out valuations, be careful in selecting the companies that comprise the peer groups. Comparable company selection could be carried out using econometric techniques that select companies on the basis of similarities in the relation between financial information and market valuation, instead of being based purely...

Is the accuracy of stock value forecasting relevant to industry factors or firm-specific factors? An empirical study of the Ohlson model

This study develops a methodology to incorporate industry and firm-specific factors into the Ohlson (Contemp Account Res 11:661–687, 1995). Residual income valuation model (RIM) and applies a time- series approach instead of the cross-sectional regression models used by existing studies. This method provides neglected valuation information when analysts’ earnings forecasts are used. The results suggest that it improves the accuracy of stock value forecasting. The inclusion of the two factors increases the forecasting ability of RIM. Furthermore, the relative importance of the two factors varies across industries. Firm-specific factors are relevant to the accuracy of stock value forecasting for three large industries (finance and insurance, electronics, building, construction and materials), whereas industry factors play a dominant role in determining the accuracy for small industries (automobile and paper). These results imply that either industry or firm-specific factors serve as crucial determinants in stock value forecasting for the five industries. In practice, investors can consider one or both of the two factors when implementing RIM to forecast stock value.

Investor sentiment, accounting information and stock price: Evidence from China

This paper analyzes the mechanism behind the effects of investor sentiment and accounting information on stock price based on the residual income valuation model. Using data from China's A-share market, we construct the sentiment index and examine the sentiment effect from the perspective of the expected earnings growth and the required rate of return. Furthermore, we investigate the joint effect of sentiment and accounting information on stock price and highlight the asymmetric effect of investor sentiment and the moderating effect of information uncertainty. The empirical results show that investor sentiment can change both the expected earnings growth and the required rate of return, thus affecting the stock price. However, the sentiment effect during pessimistic period is evidently different from that when sentiment is relatively high, especially for the required rate of return. In addition, accounting information and investor sentiment can both explain the stock price. However, accounting information is more reliable for stocks with stable earnings, whereas investor sentiment has evident asymmetric effect on stock price and should receive more focus for stocks with high information uncertainties.

A Comparative Analysis of Accounting-Based Valuation Models

We empirically compare the reliability of the dividend (DIV) model, the residual income valuation (CT, GLS) model, and the abnormal earnings growth (OJ) model. We find that valuation estimates from the OJ model are generally more reliable than those from the other three models, because the residual income valuation model anchored by book value gets off to a poor start when compared with the OJ model led by capitalized next-year earnings. We adopt a 34-year sample covering from 1985 to 2013 to compare the reliability of valuation estimates via their means of absolute pricing errors ( MAPE) and corresponding t statistics. We further use the switching regression of Barrios and Blanco to show that the average probability of OJ valuation estimates is greater in explaining stock prices than the DIV, CT, and GLS models. In addition, our finding that the OJ model yields more reliable estimates is robust to analysts-based and model-based earnings measures.

Does the vector error correction model perform better than others in forecasting stock price? An application of residual income valuation theory

This paper employs a multi-equation model approach to consider three statistic problems (heteroskedasticity, endogeneity and persistency), which are sources of bias and inefficiency in the predictive regression models. This paper applied the residual income valuation model (RIM) proposed by Ohlson (1995) to forecast stock prices for Taiwan three sectors. We compare relative forecasting accuracy of vector error correction model (VECM) with the vector autoregressive model (VAR) as well as OLS and RW models used in the prior studies. We conduct out-of-sample forecasting and employ two instruments to assess forecasting performance. Our empirical results suggest that the VECM statistically outperforms other three models in forecasting stock prices. When forecasting horizons extend longer, VECM produces smaller forecasting errors and performs substantially better than VAR, suggesting that the ability of VECM to improve VAR forecast accuracy is stronger with longer horizons. These findings imply that an error correction term (ECT) of the VECM contributes to improving forecast accuracy of stock prices. Our economic significance analyses and robustness tests for different data frequency are in favor of the superiority of VECM estimator.

The Implied Cost of Capital: An Empirical Assessment in the Tunisian Context

This research is a feedback to Wang (2015) suggesting that realized returns should be used in conjunction with ICCs to make more robust inferences about expected returns. We examine the validity of six firm-specific ICCs along with a synthetic one, in the Tunisian context, according to their feasibility and their correlation with realized return. The examined estimators are calculated according to three types of earnings forecasts: smoothing, random walk and cross-section. These estimators represent three main valuation approaches: Present Value of Expected Dividend (PVED), Residual Income Valuation Model (RIV) and Abnormal Earnings Growth (AEG). Our results confirm the assertions of Gerakos and Gramacy (2013) on random walk forecasts’ good performance as well as those of Li and Mohanram (2014) on the poor quality of Hou et al. (2012)’s cross-section forecasts. Furthermore, dividend seems best reflecting Tunisian stock market expectations concerning future revenues which would be generated by the valuated asset. These findings bring into question the relevance of new accounting valuation approaches which are anchored rather on equity book value (RIV) and on earnings forecasts (AEG).

Growth in residual income, short and long term, in the OJ model

The paper develops the valuation implications of the Ohlson/Juettner-Nauroth (Rev Account Stud 10(2–3):349–365, 2005, OJ) model having two growth parameters in the residual income dynamic—one for the long-term (g) and one for the short-term (g h ). The central result shows that the model can be transformed into \(V_{0} = BV_{0} + (RE_{ 1} /(r - g)) \cdot Scalar,\) where Scalar = 1 + (g h − g)/r. As a benchmark, the scalar equals one if and only if g = g h . The Ohlson (Contemp Account Res 11(2):661–687, 1995) residual income valuation (RIV) model with a single-growth parameter then holds. The OJ model thus generalizes and enriches the set of residual income growth patterns when g ≠ g h . A scalar greater than one admits residual income that (i) grows at a relatively large short-term rate fading downward to a long-term rate or (ii) declines over the long-term. A scalar less than one admits residual income that (iii) grows at a rate fading upward to a long-term rate or (iv) starts out negative and turns positive. Under these scenarios, the RIV model cannot hold in any meaningful sense, even as an approximation. The transformed OJ model also provides a unique angle in explaining market-to-book ratios as a function of profitability and short- and long-term growth, generating empirical implications beyond the constrained RIV model.

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

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.

The Effect Of South African Dividend And Capital Gains Taxes On Share Prices And Investor Expected Returns

<p>We examine the effect of South African taxes, specifically the secondary tax on companies (STC) and the dividends tax (DT) that replaced it, as well as capital gains tax (CGT), on investor measures of expected return and firm value. The discussion, findings, and models presented in this study are entirely original in the field of South African corporate finance research. We model the relationship between STC, CGT, and expected return and use this relationship to formulate an hypothesis of the expected behaviour of ex-ante measures of implied cost of capital for a sample of listed South African companies. We calculate these measures by formulating a unique South African version of the residual income valuation model (RIVM) and then regress derived measures of the implied equity premium on historical measures of dividend yield, ultimately concluding that investors appear to recognise the net tax benefit of dividends and capitalise this benefit into stock prices. Finally, we examine the expected position of each of these areas in light of the proposed shareholder dividend tax regime.</p>

The impact of IFRS on the value relevance of accounting data of banks listed on the Warsaw Stock Exchange

The paper aims at investigating the impact of IFRS on the value relevance of fundamental accounting data announced by banks listed on the Warsaw Stock Exchange over the period 1998–2012. Given the specificity of banking sector, the analyses were based on the Ohlson residual income valuation model. The empirical evidence indicates that observed increase in the value relevance of both book values of equity and residual incomes of banks after introduction of IFRS is statistically insignificant. The obtained results are, therefore, consistent with the findings of previous research conducted on non-financial enterprises in the context of Polish capital market.

The stock market valuation of intellectual capital in the IT industry

This study adopts the P/V ratio developed from the residual income valuation model to examine whether Taiwan’s IT companies with more intellectual capital are more likely to be mispriced by the stock market. We focus on four types of intellectual capital: human capital (measured by employees holding graduate degrees and ratio of labor costs to net sales), innovation capital (measured by R&D intensity and royalty ratio), process capital (measured by working capital turnover and fixed asset turnover), and relational capital (measured by marketing expense ratio and sales growth rate). Using 751 firm-observations in Taiwan’s IT industry during 2003–2006, the empirical results show that Taiwan’s stock market appears to overprice IT companies’ innovation capital but underprice their human, process, and relational capital. Notably, the mispricing problem is more prominent on the human capital than on the other three types of intellectual capital. A further test indicates that the mispricing of intellectual capital is due to Taiwan’s domestic investors rather than foreign institutional investors. Particularly, the mispricing problem is more prominent on the human and relational capital. The implications of these findings are discussed.

The implied cost of equity capital in the Jordanian industrial and service companies

This study estimates the implied cost of equity capital of the Jordanian companies listed at the Amman Stock Exchange using the residual income valuation model suggested by Gebhardt, Lee, and Swaminathan (GLS) (2001). The results show that the implied cost of equity capital computed from the GLS approach produces a mean of ex-ante cost of equity capital of 9.6% for the Jordanian companies listed at the ASE. We also examine whether the Jordanian firms’ cost of equity capital, based on the residual income model, is a more reliable measure of cost of equity than the realised stock returns, by investigating the association between the cost of equity capital (or realised returns) and firm-specific risk proxies. We find that the implied cost of equity capital is associated significantly with all risk proxies in the predicted directions, while the realised stock returns show a significant association only with the size of the firms and market beta. We also find that the adjusted R2 of the regression of the implied cost of equity capital on the risk proxies is higher than that of the realised stock returns. We conclude that the implied cost of equity capital derived from the residual income valuation model is a more reliable measure for the ex-ante cost of equity capital than that of the realised stock returns in terms of the association with firm-specific risk proxies.

Macroeconomic Factors and Company Value in the Context of the Ohlson Residual Income Valuation Model

Over the past decades the Ohlson Residual Income Model for equity valuation has drawn much attention concerning its advantages when compared to traditional models (DDM, FCFM). This paper attempts to empirically investigate the validity of the Ohlson Residual Income model using data from the Greek economy over the period 1969-2001. By using multiple regression analysis and by incorporating macroeconomic factors as explanatory variables, we investigate the link of accounting and macroeconomic factors in the market valuation of major Greek companies listed in the Athens Stock exchange. We find that the performance of the Ohlson Residual Income Model is quite satisfactory and the use of factors such as commodity prices, discount rates, and market level in some cases add to the explanatory power of the examined model. Our findings are important for both economists and fund managers, because they show that a relation between accounting and macroeconomic data is valid in the Greek market and economy, alongside more developed markets.

Is transaction price more value relevant compared to accounting information? An investigation of a time-series approach

The current literature on the value relevance of accounting information primarily proxies for stock values using transaction prices, a practice that some believe may mislead value relevance research conclusions. Without assuming that prices are equivalent to intrinsic values, this paper assesses the information content found in equity prices in addition to that in book values and reported earnings. We obtain two cointegration relations from the residual income valuation model and estimate trivariate error-correction models with aggregate stock market data from Taiwan. The long-run causality and common factor analyses reveal that prices have lesser fundamental information content than book values, indicating that the quarterly prices may contain sizable noise trading elements. The short-run analysis conversely suggests that prices exert a stronger causal influence compared to book values. Such a short-run misjudgment of the information role of price versus book value appears consistent with the literature indicating that investors are overconfident about their private information but underplay the value relevance of public information.

A PESQUISA E DESENVOLVIMENTO E OS PREÇOS DAS AÇÕES DAS EMPRESAS BRASILEIRAS:UM ESTUDO EMPÍRICO NA BOVESPA

The aim of the present study is to identify the relationship between spending on research and development (RD2002) and Rezende (2005) about the value-relevance of accounting information in Brazil. This empirical-analytic study was based on the model of Collins et al. (1997), which is a proxy for the Residual Income Valuation (RIV) model of Ohlson (1995), and on the classification of technological intensity in the study of Chan et al. (1990), carried out in the United States. The sample consisted of Brazilian firms with shares traded on the Bovespa between 1996 and 2006. By means of multiple regressions we identified that RD 2002) and complement the study by Rezende (2005), since our results indicate that earnings is statistically significant for stock price, with a positive relationship even after deducting R&D spending accounted for as expense. The situation is different for book value, which ceased being statistically significant and being related with stock price after deducting R&D spending accounted for as investment.

A fuzzy-based approach to residual income equity valuation

The decision of whether to buy, hold or sell equities depends on whether the current price reflects the stock’s intrinsic or fundamental value. The residual income valuation model expresses this fundamental value as a function of current book value of equity plus the sum of discounted expected residual income. Although past and present income and book value information is readily available to investors, values taken by essential parameters in this model are unknown ex ante, particularly the cost of equity or discount rate and future residual income. Any point estimate of equities’ fundamental value according to the model may therefore conceal considerable variation around the estimate, even in the presence of minor perturbations in the model’s inputs. In this paper, we introduce a fuzzy-based approach which reflects the imprecision inherent in certain parameters in equity valuation. We extend the limited prior fuzzy-based literature on investment analysis by introducing the concept of fuzzy fundamental equity value, initially on an illustrative example. To further demonstrate this fuzzy representation, illustrative financial statement data for individual UK companies are considered, with fuzzy fundamental equity values evaluated over progressive forecast horizons. Our series of illustrative applications (which encompasses the standard crisp approach) make the inherent uncertainty involved in estimating equity value immediately apparent.