Abstract
This paper compares the reliability of value estimates from the discounted dividend model, the discounted free cash flow model and the discounted abnormal earnings model. Using a large sample of Value Line 5-year horizon forecasts of the elements valued by these models, we show that the discounted abnormal earnings model outperforms the other models. Specifically, relative to both dividend and free cash flow based value estimates, abnormal earnings based value estimates are more accurate (i.e., they have smaller absolute deviations from observed security prices) and explain more of the variation in observed security prices. These results hold even for firms with book values which are expected to understate intrinsic values and for firms with the most flexibility to manage earnings. Further analyses suggest that the superiority ofthe abnormal earnings model is likely driven by the sufficiency ofbook value of equity as a measure of intrinsic value and by the greater precision and predictability of (abnormal) earnings forecasts.