Accounting, Value and the Capital Market

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Accounting, Value and the Capital Market

• Financial analysis
• future prospects
• future price
• forecasting
• intrinsic value

2
Sources of Information

• Consultants/experts
• Trade journals
• Government sources
• but
• Accounting information central as
• balance sheet measures value (capital)
• income statement measures change in value
  (profit).
• Timing critical for forecasting value

3
Ball and Brown (1968)

• Broke mould of normative accounting research
• provided empirical evidence of usefulness of
  accounting information
• A pure expectations model
• unexpected price changes
  f (unexpected earnings)

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Issues raised

• Robust to various specifications and geographical
  markets
• Post announcement drift
• Prices lead earnings
• accounting conservatism
• Prices still sensitive to accounting information
• Earnings dominate cash flow for pricing
• Earnings and cash flow interact rather than
  equivalents

6
Valuation Issues

• Share price fair value of investment
• Discounted cash flow analysis
• Cash flow Dividend
• Dividend Discount Model
• management rather than accounting decision?
• Apply basic accounting model

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Clean Surplus Earnings Applied to the Dividend
Discount Model

• the price of the company's equity capital
  equals
• the book value of the company's equity capital
• plus
• the discounted present value of its expected
  future clean surplus residual income.

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Implications

• Both income statement and balance sheet numbers
  are important for valuation.
• If clean surplus earnings are used, manipulation
  between income statement and balance sheet are
  futile.
• Except for
• Role of current figures in developing
  expectations
• Importance of words and Notes to Accounts in
  financial analysis