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Expected EPS and EPS Growth as Determinantsof Value

Abstract

This paper develops a parsimonious model relating a firm’s price per share to, (i), next year expected earnings per share (or 12 months forward eps), (ii), short-term growth (FY-2 versus FY- l) in eps, (iii), long-term (asymptotic) growth in eps, and, (iv), cost-of-equity capital. The model assumes that the present value of dividends per share (dps) determines price, but it does not restrict how the dps-sequence is expected to evolve. All of these aspects of the model contrast sharply with the standard (Gordon/Williams) text-book approach, which equates the growth rates of expected eps and dps and fixes the growth rate and the payout rate. Though the constant growth model arises as a peculiar special case, the analysis in this paper rests on more general principles, including dividend policy irrelevancy. A second key result inverts the valuation formula to show how one expresses cost-of-capital as a function of the forward eps to price ratio and the two measures of growth in expected eps. This expression generalizes the text-book equation in which cost-of-capital equals the dps-yield plus the growth in expected eps.

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Ohlson, J.A., Juettner-Nauroth, B.E. Expected EPS and EPS Growth as Determinantsof Value. Rev Acc Stud 10, 349–365 (2005). https://doi.org/10.1007/s11142-005-1535-3

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Keywords

  • Equity valuation
  • EPS
  • EPS growth
  • Dividend policy

JEL Classification

  • M41
  • G12
  • G14