Dynamic Model of Firm Valuation: A New Methodology and its Empirical Validity

Abstract

This study derives a dynamic version of the dividend discount model and assesses its empirical validity. The valuation method we propose can be easily implemented and uses widely available financial data. We find that our model produces equity value estimates that are, on average, very close to market prices, and explains a large proportion of the variation observed in contemporaneous share prices. In addition, the model we offer is a good predictor of long-term cross-sectional stock returns. For instance, a simple buy-and-hold strategy consistently earns around 22%, 37%, and 49% returns after one, two, and three years of portfolio formation.