A Profit System Model of the Firm for Business Analysis and Stock Valuation

Abstract

As discussed in Chapter 2, dynamic relationships exist between sales (output), profit, profit rate, profit margin, and capital stocks of firms – that is, the values (magnitudes) of these fundamental variables in any period depend on the current and past values of the other variables. Consequently, for purposes of business analysis, an integrated business model of firms must contain all the dynamic relationships among these variables. Our profit system models in Chapter 2 provide analytical frameworks for short-run and long-run analyses of these fundamental variables over time. Here we apply the profit system model to individual firms for business analysis, forecasting, and stock market valuation. Regarding stock market valuation, we integrate the profit system model and the popular discounted cash flow (DCF) stock valuation model to perform in-sample analyses and out-of-sample forecasts of individual firms’ stock values.