The Role of Book Value in High-Tech Valuation

By Xu, Lianzan; Cai, Francis et al. | Advances in Competitiveness Research, Annual 2007 | Go to article overview

The Role of Book Value in High-Tech Valuation


Xu, Lianzan, Cai, Francis, Leung, C. K., Advances in Competitiveness Research


ABSTRACT

This paper investigates the anomalous relationship between negative earnings and stock prices for the high-tech sector. We obtain evidence rejecting the claim that including book value in the valuation specification eliminates the anomalous relationship. Test results indicate that sales revenues are more value relevant than reported negative earnings in the valuation of high-tech loss firms.

INTRODUCTION

The negative price-earnings relation for firms that report losses, as reported by Jan and Ou (1995) and documented by Burgstahler and Dichev (1997) and Kothari and Aimmerman (1995), raises questions about the validity of the assumption of a positive and homogeneous relation between price and earnings, as expressed by the simple earnings capitalization model. A negative coefficient on earnings means that the more negative is a firm's earnings per share, the higher is its stock prices, which makes no economic sense at all. Collins et al. (1999) hypothesize and find that including book value of equity in the simple earnings capitalization model eliminates the negative relation. They explain that book value of equity is a proxy for expected normal future earnings, which is especially important for loss firms regarding valuation. The omission of book value in the simple earnings capitalization model renders the model mis-specified, introducing a positive bias to the coefficient on earnings for profit firms and a negative bias to the coefficient on earnings for loss firms.

We investigate the anomalous negative price-earnings relation for firms that report losses in the high-tech sector during the 1990 to 1999 ten-year period, a period when high-tech industry enjoys unprecedented growth. High-tech companies do not usually report profits or positive operating cash flows. They usually have big investments in intangible assets and large R&D expenditures, which, according to SFAS #2, must be fully expensed (Lev and Sougiannis, 1996). As such, earnings are not really as important and book value can hardly be a measure of a firm's true wealth (Barron et al., 2002).

We hypothesize and find the positive coefficient on earnings for high-tech profit firms and the anomalous negative coefficient on earnings for high-tech loss firms. We hypothesize and find that including book value of equity in the simple earnings capitalization model does not eliminate the negative price-earnings relation for loss firms. We hypothesize and find evidence suggesting that sales are more value relevant than earnings or book value for high-tech loss firms (Davis, 2002, Jahnke, 2000).

Our study contributes to the current literature by providing further evidence of the anomalous relation between price and negative earnings for high-tech loss firms. We demonstrate the persistence of the anomaly and rejecting the claim that the inclusion of book value of equity in the model eliminates the anomaly, for the high-tech sector. We also provide evidence of the value relevance of sales for high-tech firms.

Section II discusses the sample selection and data. Section III presents the testing results of the negative price-earnings relation for high-tech loss firms. Section IV provides the empirical evidence of regressing stock price on earnings, book value, and sales. Section V is a summary and conclusion.

HIGH-TECH SAMPLE AND SUMMARY STATISTICS

Our sample for the high-tech companies involves the drug, computer, networking and telecommunication industries. Table 1 is a description of the industries in the sample in the three-digit SIC code.

We incorporate all firm-year observation during the 1990 to 1999 period in the 2000 Standard and Poor's COMPUSTAT CD-ROM active and research databases. The research file is included in the study to mitigate survivorship bias. All variables in this study are measured on a per share basis. Firm-year observations are eliminated of which (1) December is not the fiscal year end, (2) stock price three months after the fiscal year end is missing or negative, (3) earnings per share data is missing, (4) beginning of year book value of equity is missing, (5) sales per share is missing or negative, and (6) the total number of common shares outstanding decreases 1/3 from the previous year as it is suspect of a reverse stock split to maneuver earnings per share. …

The rest of this article is only available to active members of Questia

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

(Einhorn 25)

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Note: primary sources have slightly different requirements for citation. Please see these guidelines for more information.

Cited article

The Role of Book Value in High-Tech Valuation
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Help
Full screen
Items saved from this article
  • Highlights & Notes
  • Citations
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

matching results for page

    Questia reader help

    How to highlight and cite specific passages

    1. Click or tap the first word you want to select.
    2. Click or tap the last word you want to select, and you’ll see everything in between get selected.
    3. You’ll then get a menu of options like creating a highlight or a citation from that passage of text.

    OK, got it!

    Cited passage

    Style
    Citations are available only to our active members.
    Buy instant access to cite pages or passages in MLA 8, MLA 7, APA and Chicago citation styles.

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

    "Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

    1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

    Cited passage

    Thanks for trying Questia!

    Please continue trying out our research tools, but please note, full functionality is available only to our active members.

    Your work will be lost once you leave this Web page.

    Buy instant access to save your work.

    Already a member? Log in now.

    Search by... Author
    Show... All Results Primary Sources Peer-reviewed

    Oops!

    An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.