Stephen Penman

Return to Fundamentals

This article outlines research developments that reconcile both fundamental analysis and accounting measurement to the modern theory of valuation. Three features of accounting suggest it may play a role. First, it has the nominal attributes of a value measurement system. The financial accounting process is focused on tracking the book value of equity or net worth. The final entry in the periodic accounting cycle is the close to book values. Second, it is a disciplined system for reporting phenomena that is bound by rules that produce a value-added number that is independent of dividends: the calculation of earnings does not involve dividends. Third, accounting has a connection to future dividends, dividends are paid from postclosing book values. Book values must exist before dividends can be paid. On face value at least, accounting is a system of measuring value and value accretion. The prevailing orthodoxy directs to pierce through the accounting and to discount future cash flows (DCF), not earnings. DCF is the standard of modern finance that is supposed to deal with the dividend conundrum. This revision in the methods of the fundamentalist came from a recognition that no one really know how to discount expected future earnings to get value.

Source: Journal of Accounting, Auditing and Finance
Exact Citation:
Penman, Stephen. "Return to Fundamentals." Journal of Accounting, Auditing and Finance 7, no. 4 (Fall 1992): 465-483.
Volume: 7
Number: 4
Pages: 465-483
Date: Fall 1992