Alternative equity valuation models

Abstract

This chapter examines alternative equity valuation models and their ability to forecast future stock prices. Equity valuation models included Ohlson′s (1995) Model, Feltham and Ohlson′s (1995) Model, and Warren and Shelton′s (1971) Model. Five research hypotheses are developed to examine whether different estimation techniques, earnings measures, and combined forecasting methods can improve the ability to predict future stock prices. We find that the simultaneous equation estimation procedure can produce more accurate future stock price forecasts than the traditional single equation estimation method in terms of smaller prediction errors. In addition, the combined forecast method can further reduce the prediction errors by using combination of individual forecasts. Empirical evidence also shows that investors can use comprehensive earnings to more accurately forecast future stock prices in these valuation models. We use simultaneous equation estimation technique to investigate the stock price forecast ability of Ohlson′s Model, Feltham and Ohlson′s Model, and Warren and Shelton′s (1971) Model. Moreover, we use the combined forecasting methods proposed by Granger and Newbold (1973) and Granger and Ramanathan (1984) to form combined stock price forecasts from individual models. Finally, we examine whether comprehensive earnings can provide incremental price-relevant information beyond net income.