A COMPARISON OF DIVIDEND, CASH FLOW, AND EARNINGS APPROACHES TO EQUITY VALUATION
The calculation of equity value is typically characterized as a projection of future payoffs and a transformation of those payoffs into a present value (price). A good deal of research on pricing models has focused on the specification of risk for the reduction of the payoffs to present value but little attention has been given to the specification of payoffs. It is noncontroversial that equity price is based on future dividends to shareholders but it is well-recognized that dividend discounting techniques have practical problems. A popular alternative-- discounted cash flow analysis--targets future "free cash flows" instead. Analysts also discuss equity values in terms of forecasted earnings and the classical "residual income" formula directs how to calculate price from forecasted earnings and book values. It is surprising that, given the many prescriptions in valuation books and their common use in practice, there is little empirical evaluation of these alternatives
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