Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

THE REPORTING OF EARNINGS AND EQUITY VALUATION

IS NIKE BACK IN STYLE?. . . The Street seems to think so. Alex. Brown raised Nike to buy from market perform; Morgan Stanley upped it to a strong buy; Goldman upped it to market outperform. Why all the kisses? Well, Nike beat analyst estimates by a whole penny! Good dog! It’s okay that earnings were 4 cents versus 52 cents last year, that revenues fell 3 percent, that worldwide futures orders were down 13 percent, and that there’s no sign of renewed sneaker sales in Asia. Oh, yeah, and that earnings figure excludes a $130 million restructuring charge. Include it, and the company lost $67.7 million, its first loss in more than a decade. (But we all know restructuring isn’t real money.) None of that matters, because Nike’s stock costs only $52 versus $58 at this time last year. And everything else has gone up, so really, Nike’s even cheaper! Haven’t you heard of relative value?

—Serwer (1998)

We just want you to remember that accounting earnings are slippery animals. . . to be forewarned is to be forearmed.

—Brealey and Myers (1991)

In the first section, “Evidence on the Relevance of Earnings to Valuation,” we presented evidence on the association between accounting data and security prices and returns. This section begins with a brief discussion of a valuation model that is derived from the dividend discount model and uses accounting data as a direct input. The fundamental strength of this model is that it is consistent with traditional ...