Dividend policy irrelevancy and the construct of earnings

This paper analyzes the characteristics of earnings in valuation settings where the dividend policy is irrelevant to equity value. The paper first demonstrates an equivalent characterization of dividend policy irrelevancy (DPI) in a general linear dynamic. It then proceeds to show how DPI leads to ideal and practical constructs of earnings and examines their analytical properties. We further demonstrate that earnings properties can be used to deduce the core approach in practical equity valuation - namely, measures of growth in expected earnings explain the price to forward earnings ratio. However, unlike dividends, free cash flow cannot generally be claimed to be irrelevant to value.