On the relevance of earnings components in valuation and forecasting
Review of Quantitative Finance and Accounting
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This paper articulates the links between relevance of an earnings component in forecasting (abnormal) earnings and its relevance in valuation in a nonlinear framework. The analysis shows that forecasting relevance does not imply valuation relevance even though valuation irrelevance is implied by forecasting irrelevance. Firstly, I consider an accounting information system where earnings components "add up" to a fully informative earnings number. Secondly, I analyze two accounting systems where a "core" earnings component is the relevant earnings construct for valuation and the second earnings component is irrelevant but may be predictable and relevant in forecasting other accounting items. I find that dividend displacement effect on earnings and the dynamics of individual earnings components are critical in this analysis.
Pre-print also submitted to SSRN Archive. The final publication is available at Springer via http://dx.doi.org/ 10.1007/s11156-013-0347-y
Vol. 42 (3), pp. 399-413