Valuation Techniques: Discounted Cash Flow, Earnings Quality, Measures of Value Added, and Real Options

POLICY IMPLICATIONS

Two policy implications emerge from this analysis. The principal conclusion is that efforts to determine which measure of earnings is appropriate for a company to disseminate are misguided. There is no clear theoretical or empirical basis for consistently preferring one measure over another. As inputs to investor valuation analyses, “earnings” definitions will vary over time and among companies. In some situations, investors will find working with basic line items, such as revenues, costs, and capital used, more appropriate than computing any measure of earnings. In such circumstances, companies should be free to aggregate the component financial data in any fashion they believe provides the most useful information to investors.

What is critical is that the basic elements that make up any measure of earnings be presented with sufficient clarity and at a sufficient level of disaggregation that investors can answer such fundamental questions as: What were the revenues generated by operations? What were the costs associated with generating those revenues? And how much capital was required to generate those revenues? If sufficient information is available to answer such questions, investors can aggregate the information into an earnings measure they believe is most appropriate for forecasting future cash flows. In its proposal Reporting Information about the Financial Performance of Business Enterprises, the FASB (2001) suggested that it would consider requiring ...