A Generalized Earnings Model of Stock Valuation

By Andrew AngJun Liu
1998| Working Paper No. 1494

Traditional approaches to valuing equities have largely focused on the Dividend Discount Model. It may be hard to reliably estimate dividend processes in small samples and market participants focus primarily on earnings and other accounting information in analyzing stocks. For these reasons we try to value stocks using earnings and book value. Building on the seminal work of Miller and Modigliani (1961) and Ohlson (1990, 1995) we develop no-arbitrage model which uses stochastic pricing kernels. The models can be implemented by assuming the driving variables follow affine processes which allows tractable calculations. We apply the model to several individual stocks.