Equity Valuation Using Multiples: An Empirical Investigation

Introduction 7residual income valuation model, which builds on Marshall (1898), Preinreich(1938), Edwards & Bell (1961), and Peasnell (1981 and 1982). This model definesthe value of a firm as the sum of the book value of common equity and the discountedpresent value of expected future abnormal earnings (i.e., earnings in excessof the cost of the expected book value of common equity in future years). In fact,the model is a transformation of the dividend discount model (DDM), but expressesvalue directly in terms of current and future accounting numbers, book values, andearnings (see Kothari 2001, p. 142). By reinterpreting the theoretical findings ofOhlson (1995) and Feltham & Ohlson (1995), there might be a potential to alsocombine book values and earnings in a multiples-based valuation framework. Thispotential is examined and expressed as a separate research question.• Research question 3: Is it useful, from a theoretical point of view, to combineinformation from book values and earnings into a two-factor multiples valuationmodel?1.2.2 Research questions for the empirical partTheoretical explanations, however, are only one part of the game. Open issuesand inconsistencies remain; moreover, both the scientific and the practical communitydemand empirical tests of theoretical outcomes. Therefore, I enhance the theoreticalpart of the research with a broad empirical study of European and U.S. equitymarkets.Different valuation methods imply competition, in which only efficient methodscan survive. Efficient, in this setting, means that the benefits of a valuationmethod must outweigh the cost of using it, and its cost benefit tradeoff must comparefavorably with alternative methods (Penman 2004, p. 66). Obviously, the multiplesvaluation method is “cheap,” but in order to compete with more complexmethods, such as the DCF or the RIV model, it has to prove a certain level of valuationaccuracy. Hence, the first research question of the empirical part deals with thevaluation accuracy of the multiples valuation method.