What is Abnormal Earnings Valuation?

The abnormal earnings valuation method is one in which the future cash flows of a business are given significant weight in a valuation, especially when there are not many hard assets to use for valuation purposes.

If a company is rich in human capital or has significant cash flows, whether or not it has many hard asset or book value, the Abnormal Earnings Valuation Model can be the most useful method for arriving at an accurate valuation of a business and its stock.

Other valuation methods using cash flows exist, such as the Dividend Discount Model (DDM) and other Discounted Cash Flow (DCF) models, but these may not be appropriate for a company that has an unpredictable dividend or that has a negative free cash flow for a number of years yet.

These also only look at the cash flows, whereas abnormal earnings valuation looks at book value plus earnings in excess of the expected baseline. It could also anchor the valuation in current earnings instead of book value. This valuation method is usually synonymous with the Residual Earnings Growth Model.