Cut to the Chase: A Study of the Usefulness of a Simplified Residual Income & Abnormal Earnings Growth Model

Abstract: This study explores the usefulness of two simplified accounting based valuation models; the simplified residual income and simplified abnormal earnings growth models. With a quantitative approach, the companies on the Stockholm Stock Exchange’s Large Cap List have been used as a sample for two tests. First we have, by conducting a historical analysis, tried to find company characteristics that would imply better compatibility with the models. Further, we have applied the models on a holdout sample in order to test the observed patterns and the accurateness of the models. Our results show that the two models are applicable on companies that are; old, preferably large and operate in mature industries. In addition, we find that the simplified residual income valuation model is applicable on more companies than the simplified abnormal earnings model.