Accounting Earning, Book Value and Cash Flow in Equity Valuation: An Empirical Study on CNX NIFTY Companies

Way back in 1934, Graham and Dodd observed the importance of earning power in investment theory. According to them, history of actual earning with a reasonable expectation should be approximated in future. The empirical study of Ball and Brown (1968) contends that of all the sources of information as regards the working of a firm during a year, income number reported in the annual income statement captures one-half or more. In the backdrop of relevance of accounting numbers for equity valuation, Feltham and Ohlson (1995) and Ohlson (1995) provide an objective valuation model based on abnormal earning. According to the models, the fundamental of valuation depends on abnormal earning—an autoregressive process of the first order [AR(1)] that is related to the abnormal earning of the previous period. Along with abnormal earning there may be other variables like book value of the equity, operating cash flow, accruals and other information (all of them being autoregressive, AR(1), processes) can be usedseverally and jointly for predicting equity value. In the present paper, an attempt has been made to test the forecasting ability of equity share value of CNX NIFTY companies of the National Stock Exchange of India empirically for a period of 10 years (1999-2008) by pooling cross-sectional data on abnormal earning, book value and operating cash flow in line with the forecasting and valuation equation models of Feltham and Ohlson (1995) and Ohlson (1995). The findings suggest that abnormal earning, book value and operating cash flow component of earning respectively follow an autoregressive process. Information on abnormal earning and book value aids in predicting equity value. The findings are consistent with Ohlson’s model.