The Transitory Nature of Negative Earnings and the Implications for Earnings Prediction and Stock Valuation

An attempt is made to, in the context of a fundamental approach, develop and empirically test a sales-based model that is consistent with valuation theory for the purpose of developing an assessment of expected future earnings for loss firms. The objective is to: 1. develop a Sales-based Assessment of Future normal Earnings (SAFE) as a basis for earnings prediction that incorporates controls for expected trends in profitability rates and the likelihood of firm survival, 2. establish a link between SAFE and future earnings realizations, 3. demonstrate the relative superiority of SAFE as a value relevant variable over price-earnings and price-sales models, and 4. express the relative role of SAFE as a surrogate for value as a going concern in conjunction with the abandonment opinion held by investors. Results indicate that there is a significant relationship between the expected earnings from the sales-based earnings prediction model and future earnings realizations.