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

CONCLUSIONS

The aim of this analysis is to see whether the value-added measures when applied to the firm as a whole align with market measures of performance. If they do, confidence is gained in using such measures to evaluate aspects of the firm’s management, such as a division or a product line. In particular, those measures that do not rely on market values (which would not be available for such aspects as a division) are of particular interest. Return on capital, using the refinements in adjusting accounting data to better reflect economic reality, appears promising. This measure correlates significantly with stock price performance and does not rely on market values in its construction, but we do not find that this measure is empirically more closely related to stock returns than the traditional measures. This finding suggests that the parsimonious, but less theoretically pleasing, traditional measures should not be eliminated from consideration in performance evaluation.

From the perspective of an analyst, do value-added measures add value? The change in market value added is correlated with stock returns. Should the analyst thus use market-value-added measures to evaluate the performance of a firm? Not necessarily. Market-value-added measures may not be superior to stock returns for several reasons:

• Market-value-added measures, as strictly applied, suffer from a size bias. Even when adjustments are made to reduce this bias, market-value-added measures do not adjust for ...