Equity Valuation Employing the Ideal versus Ad Hoc Terminal Value Expressions

How Good are Equity Valuation Models in Predicting Stock Prices?

“…Previous studies tend to compare dividend discount, discounted cash flows and abnormal earnings models as intrinsic valuation approaches (Cassia et al, 2009;Courteau et al, 2001; Francis et al 2000; Pennan et al 1998, among others). Multiple based models are rather discussed separately or seen as an addition to the previous three models (Liu, Nissim andThomas, 2002 andKaplan et al, 1995).…”

“…Among practitioners the free cash flow and dividend discount models complemented with multiples valuations are the most common procedure making the abnormal earnings model less widespread (Faroq et al, 2010 and Demirakos et al). Although there is consensus that models based on discounted cash flows, discounted dividends as well as abnormal earnings should in theory provide the same valuation if applied for an infinite time horizon, empirical results shows that valuation results differ (Jorgensen et al, 2005;Pennman, 2001;Francis et al, 2000;Courteau et al, 2001, among others).These practical differences might occur if input factors are not consistent or a finite model horizon is applied (Pennam, 2001 andFrancis et al, 2000). Contrary to this Lundholm and O'Keefe (2001) reject the assumption that different models are allowed to yield different valuations even if applied in a finite rather than infinite time horizon.…”

“…Courteau et al (2001) and Francis et al (2000) use a simple approach that measures the prediction exactitude by comparing the mean intrinsic firm value with the mean actual market prices. 1 Francis et al (2000) additionally test the central tendency and Courteau et al (2001) divide the valuation in its components and analyse the skewness and standard deviation of the model outcomes. In contrast, Penman et al (1998) measure model accuracy by forming random portfolios to eliminate market inefficiencies and average out the unpredictable component using ex-post data.…”

“…An interesting figure is that the corporate marginal tax rate constantly decreases over the 20 years of the sample (from 60 percent in 1990 to 29 percent in 2010). 5 The corporate tax rate is settled equal for each company as the aggregate country average in each year. The firm's capital structure was assumed unchanged for the terminal value calculation.…”

“…4 Since the valuation models are tested with a three year forecast horizon and one year observation for the terminal value 2006 is the last year for which valid valuations are made using accounting and market data until 2010. 5 The corporate tax rate in Germany is partly relying on trade tax and a solidarity surcharge. Therefore, company's taxation might vary depending on their location.…”