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Abnormal Earnings Valuation Model

What is the 'Abnormal Earnings Valuation Model'

The abnormal earnings valuation model is a method for determining a company's worth that is based on book value and earnings. Also known as the residual income model, it looks at whether management's decisions cause a company to perform better or worse than anticipated. The model says that investors should pay more than book value if earnings are higher than expected and less than book value if earnings are lower than expected

Explaining 'Abnormal Earnings Valuation Model'

There are numerous other methods for valuing companies, including P/E ratio, price-to-book value ratio, return on equity, return on capital employed and discounted cash flow. Investors and analysts should not place too much emphasis on any one of these (or a number of other) measures of value because no single method can provide a complete picture of a company's financial performance.

Further Reading

Residual earnings valuation with risk and stochastic interest rates
meridian.allenpress.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Linear accounting valuation when abnormal earnings are AR (2)Linear accounting valuation when abnormal earnings are AR (2)
link.springer.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Unrecorded intangible assets: Abnormal earnings and valuationUnrecorded intangible assets: Abnormal earnings and valuation
meridian.allenpress.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Comparing the accuracy and explainability of dividend, free cash flow, and abnormal earnings equity value estimatesComparing the accuracy and explainability of dividend, free cash flow, and abnormal earnings equity value estimates
www.jstor.org [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Effect of R&D investments on persistence of abnormal earningsEffect of R&D investments on persistence of abnormal earnings
www.emerald.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

The persistence of abnormal earnings and systematic riskThe persistence of abnormal earnings and systematic risk
www.sciencedirect.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

The economic value of the R&D intangible assetThe economic value of the R&D intangible asset
www.tandfonline.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Comments onAn empirical assessment of the residual income valuation model'Comments onAn empirical assessment of the residual income valuation model'
www.sciencedirect.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

An empirical examination of the value relevance of intellectual capital using the Ohlson (1995) valuation modelAn empirical examination of the value relevance of intellectual capital using the Ohlson (1995) valuation model
www.emerald.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Valuation and clean surplus accounting for operating and financial activitiesValuation and clean surplus accounting for operating and financial activities
onlinelibrary.wiley.com [PDF]
… where the probability function f determines expected dividends and the covariance between dividends and the valuation index … one obtains a formula expressing value as equal to book value plus the present value of risk-adjusted expected abnormal earnings, given some …

Q&A About Abnormal Earnings Valuation Model

How do you abbreviate abnormal earnings valuation model?

AEVM.

What are some examples of abnormally high or low earnings that would cause a stock to be undervalued or overvalued respectively?

Examples include companies with an unsustainable competitive advantage, such as a patent on a product that has not yet expired; companies with very high growth rates in sales, profits, or cash flow; and companies whose prices have been depressed by industry-wide problems.

What does the abnormal earnings valuation model say about investors?

It says that investors should pay more than book value if earnings are higher than expected and less than book value if earnings are lower than expected.

Where did the concept of abnormal earnings come from?

The concept of abnormal earnings came from Ben Graham and David Dodd's book Security Analysis in 1934.

What does AEVM stand for?

Abnormal Earnings Valuation Model.

How many methods of valuing companies exist?

There are numerous other methods for valuing companies, including PE ratio, price-to-book value ratio, return on equity, return on capital employed and discounted cash flow.

Why should investors not place too much emphasis on any one of these (or a number of other) measures of value because no single method can provide a complete picture of a company's financial performance?

Because no single method can provide a complete picture of a company's financial performance.

What is the abnormal earnings valuation model?

The Abnormal Earnings Valuation Model is a method for determining a company's worth that is based on book value and earnings.

48 replies on “Abnormal Earnings Valuation Model”

[…] Market capitalization is equal to the share price multiplied by the number of shares outstanding. Since outstanding stock is bought and sold in public markets, capitalization could be used as an indicator of public opinion of a company's net worth and is a determining factor in some forms of stock valuation. […]

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