THE DIVIDEND DISPLACEMENT PROPERTY AND THE SUBSTITUTION OF ANTICIPATED EARNINGS FOR DIVIDENDS IN EQUITY VALUATION

The paper demonstrates empirically that earnings prepared according to Generally Accepted Accounting Principles (GAAP earnings) have propert ies necessary to serve as a substitute for dividends in equity valuati on analysis. Dividends reduce subsequent GAAP earnings, and ''intrinsi c'' equity prices calculated by forecasting earnings are thus reduced by current dividends. This behavior is in accordance with the Miller a nd Modigliani principle-the displacement property-which states that th e payment of dividends reduces prices, dollar for dollar. Further, the paper demonstrates that if this displacement is accommodated in calcu lating equity prices from forecasted GAAP earnings, those prices exhib it the dividend irrelevance property, that is, calculated prices are i nsensitive to future dividends. Forecasted GAAP earnings cannot be sub stituted for dividends, dollar for dollar, but the two are substitutes in the sense that the replacement value of expected dividends reduces forecasted earnings, dollar for dollar.