as we all know, it measures the economic profit of the firm, taking in all opprotunity costs of capital. If a firm’s net income, after subtracting the required rate of return on equity, is negative…what does it mean really?? I am just trying to relate that to the stock’s price…, or do they not relate at all? what will the price be if the return is not enough to cover required return??? I was thinking in line of trading below instrinsic value…but that doesn’t make sense thanks.
If the RI couldn’t cover the required return on equity, and also assuming this holds in future periods, I would short the stock.
The residual income valuation model values a company at its book value plus the present value of it’s expected residual income. If economic profit is negative, the price of the stock will be less than book value. It will stay in business as long as the value is greater than the liquidation value.