Discussion of ‘‘On Accounting-Based Valuation
Formulae’’ and ‘‘Expected EPS and EPS Growth
as Determinants of Value’’
STEPHEN H. PENMAN firstname.lastname@example.org
Graduate School of Business, Columbia University, New York, NY, 10027
Abstract. This discussion evaluates the abnormal earnings growth valuation (AEG) Model of Ohlson and
Juettner-Nauroth and, in similar vein to the Ohlson review paper at this conference, compares the Model
to the residual income valuation (RIV) Model that has been the centerpiece of accounting-based valuation
in recent years. The discussion begins with a statement of what one looks for in a practical valuation
model. The innovations of the AEG Model, well stated by Ohlson, are acknowledged. A comparison of
the advantages and disadvantages of the alternative approaches provides some qualiﬁcation, however, and
draws out the utility of a residual income valuation approach.
Keywords: equity valuation, residual income, earnings growth
JEL Classification: M41
During the last several years, residual income valuation (RIV) has become the
centerpiece of accounting based valuation. In his two conference presentations, James
Ohlson presents an alternative, abnormal earnings growth valuation (AEG), along
with a critique of RIV. A choice between models is being oﬀered. In this discussion I lay
out the advantages and disadvantages of the two approaches as I see them.
It is of course imperative that a valuation model be consistent with valuation theory,
but it is not suﬃcient. Valuation models are utilitarian – they serve to guide practice – so
the choice between competing technologies ultimately comes down to how useful they
are for the practical task of evaluating investments. The RIV Model has increasingly
been advocated as a practical alternative in ﬁnancial statement analysis texts and
valuation practice, but is now challenged in the (Ohlson, 2005) review paper.
I see four roles for a valuation model to which I will appeal in the discussion.
First, a model speciﬁes what is to be forecasted when valuing a ﬁrm. RIV Models
diﬀer from dividend discount models by prescribing earnings and book values, ra-
ther than dividends, as the forecasting target. AEG Models diﬀer from RIV Models
by specifying earnings per share rather than earnings and book values as the focus.
What attribute should the equity analyst focus on?
Second, a model directs how to go about the task of analyzing the information to
develop the forecast; in practical terms, it guides how we carry out pro forma analysis
that builds the forecast. How does the analyst design a spreadsheet to value equities?
Third, a model prescribes how to convert a forecast to a valuation. Given a
forecast developed via pro forma analysis, what is the implied valuation?
Review of Accounting Studies, 10, 367–378, 2005
Ó 2005 Springer Science+Business Media, Inc., Manufactured in The Netherlands.