This study examines the usefulness of an residual income model in predicting cross-sectional returns. The valuation method used in this study is the Edwards-Bell-Ohlson(EBO) Valuation technique, a discounted residual income model. Firms` fundamental values(FV) were estimated using analyst forecasts of DAEWOO Research Center and a residual income model developed by Ohlson. Quintile portfolios based on FV/P, firms` beta, firms` size(ME), and B/P were constructed. This study found that portfolios with higher (lower) FV/P showed higher (lower) stock returns over 1-year, 2-year, and 3-year period. The same results were found after a firm`s beta, total market capitalization, or B/P ratio were controlled. FV/P effect is not explained by a firms`s beta, total market capitalization, or B/P ratio. In addition, FV/Ps by industry were compared and it was tested whether FV/P explains stock returns regardless of industry type. FV/P was found to be different by industry. However, the analysis with sub-samples by industry showed that FV/P effect existed in all industry groups.
