O'Reilly logo

The Valuation Handbook: Valuation Techniques from Today's Top Practitioners by Rawley Thomas, Benton E. Gup

Stay ahead with the world's most comprehensive technology and business learning platform.

With Safari, you learn the way you learn best. Get unlimited access to videos, live online training, learning paths, books, tutorials, and more.

Start Free Trial

No credit card required

CHAPTER 7
Residual Income and Stock Valuation Techniques
Does It Matter Which One You Use?
 
Benton E. Gup
Chair of Banking, University of Alabama
Gary K. Taylor
Associate Professor, University of Alabama
 
 
Common stockholders are the residual claimants of corporations. It follows that whatever cash flows remain after creditors have been paid are residual cash flows.1 In essence, all discounted cash flow (including dividends) stock valuation models could be considered residual income valuation models. However, advocates of economic value added (EVA), residual income (RI), and abnormal earnings growth (AEG) valuation methods have a specific definition in mind when using the term residual income. For these three models, RI represents earnings above or below normal earnings. Normal earnings are those earnings generated by multiplying the required rate of return by the book value of equity.2
All three of these valuation techniques are used on Wall Street and taught in business schools. By way of illustration, consider Stowe et al., Analysis of Equity Investments: Valuation (2002). The chapter on residual income valuation states that EVA is a commercial implementation of the residual income “concept.” Similarly, Hirst and Hopkins, in Earnings: Measurement, Disclosure, and the Impact on Equity Valuation (2000), show that EVA is a specific version of the RI valuation model. However, EVA, RI, and AEG methods of valuation are quite different in their implementation. This chapter clarifies ...

With Safari, you learn the way you learn best. Get unlimited access to videos, live online training, learning paths, books, interactive tutorials, and more.

Start Free Trial

No credit card required