Empirical Evidence on Retail Firms’ Equity Valuation Models

Topics: Generally Accepted Accounting Principles, Stock market, Discounted cash flow Pages: 27 (10024 words) Published: May 17, 2011
International Research Journal of Finance and Economics ISSN 1450-2887 Issue 7 (2007) © EuroJournals Publishing, Inc. 2007 http://www.eurojournals.com/finance.htm

Empirical Evidence on Retail Firms’ Equity Valuation Models Anastasia Vardavaki 13 Epidavrou str., Halandri, 152 33 Athens, Greece E-mail: anastasia_vardavaki@yahoo.gr John Mylonakis 10 Nikiforou str., Glyfada, 166 75 Athens, Greece E-mail: imylonakis@panafonet.r Abstract This paper presents the theoretical framework for the process of equity valuation and investigates the relative explanatory power of alternative linear equity valuation models when applied to firms in the UK food and drug retail sector. Due to practical difficulties in applying all valuation models, the empirical tests for the equity valuation are based on a) the asset-based model, which contains only book value as an independent variable; b) the earnings-based model, and c) the combined model, which contains both book value and current earnings or abnormal earnings as value-relevant variables. The results of the empirical analysis support precious studies that the combined valuation model is more informative by providing better and more accurate estimations of equity market values. This can be explained by the fact that this model incorporates both the economics and the accounting characteristics of the examined firms. Key words: Equity Valuation Models, Asset-Bards Model, Discounted Cash Flow Model, Discounted Residual Income, Equity Market Value JEL classification: G 380

1. Introduction
Fundamental analysis entails the use of information in current and past financial statements, in conjunction with industry and macroeconomic variables in order to determine the firm’s intrinsic value. To a fundamental analyst, the market equity price tends to move towards the fundamentalintrinsic value. A difference between the current and the intrinsic value is an indicator of the expected excess rewards for investing in the security. A large body of research demonstrates that economically significant abnormal returns spread over several years can be obtained by implementing fundamental analysis trading strategies. Equity valuation itself constitutes a fairly significant issue that has generated the intense interest of various economic and financial analysts. Valuation research has emerged as a central theme in the accounting research of the 1990s. This literature has had a substantial impact on the research agendas of academics and on the day-to-day work of practitioners. According to the ‘Efficient Market Hypothesis’, as defined by Fama (1970, 1991), security prices fully reflect all available information. Whether security markets are informationally efficient is of great interest to investors, shareholders, managers, lenders, standard setters and other market participants who care about intrinsic value of the firm.

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International Research Journal of Finance and Economics - Issue 7 (2007)

There are several important valuation models that are applied for the purpose of determining the firm’s fundamental value. In an ideal world, where markets are perfect and efficient, the intrinsic firm value equals the equity book value. However, in the real world, the book value of shareholder equity is generally lower than the market equity value. That is, the book-to-market ratio is less than the unity. The purpose of this paper is to present the theoretical framework of equity valuation models (Asset-Based, Discounted Cash Flow and Discounted Residual Income) and to empirically test these valuation models in a sample of UK food-drug retail companies, including a discussion of diagnostic tests and some important econometric issues.

2. Theoretical framework on Equity Valuation Models
Valuation is the process of forecasting the present value of the expected payoffs to shareholders and of converting this forecast into one number that corresponds to the fundamental-intrinsic firm value. Lee (1999)...

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International Research Journal of Finance and Economics - Issue 7 (2007) PANEL D: 2001
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