Since the early 1990s, there has been a rebirth in fundamental analysis, the process of using accounting information to value a firm. [(Penman, 1992), (Bernard, 1994), and (Imhoff, 1998)]. Earlier studies, such as Ball and Brown (1968) found that net income is of particular interest to investors. This is used as a predictive criterion by investors for investment decisions as it is reflected in security prices. Beaver (1968) also states that the information content of earnings is an issue of obvious importance. The objective of this research study is to examine whether the capitalisation of earnings (the income approach) firm valuation methodology is a good proxy to value a firm or a business. The three firm valuation models (the stabilised income method, the discounted future income method, and the discounted dividend valuation method) used in this research study all developed from the theoretical framework of the capitalisation of earnings firm valuation methodology.
Eight Australian companies that cover three industries have been used as the sample companies in this research study. Four hypotheses have been developed. The first three hypotheses aim at to test whether there is any significant differences between the theoretically calculated firm value with that of the firm's actual share market price. The fourth hypothesis aims at to test whether the three firm valuation models are equally good at estimating firm value. In this research study, the conclusion is that Model 3 (the discounted dividend valuation method) appears to have the best potential in estimating firm value. Compared to Model 3, owing to the data of Models 1 and 2 have been affected in a more significant degree by the arbitrary choice of the 4 % annual growth rate of income, Models 1 and 2 result in relatively poor performance in estimating firm value.
Accounting information such as earnings and dividends have been used to compute the theoretically calculated firm value of the eight sample companies. This research report contributes to the empirical study of the relationship between accounting numbers and firm value. Finally, a number of potential research directions are suggested.