We cover how to create a Residual Income model to value a stock in Excel. Residual income is the income after considering all of a company’s capital. Residual income is also sometimes referred to as economic profit because it estimates the company’s profit after subtracting both debt and equity. This is unlike a company’s income statement which only includes a charge for the cost of debt in the form of interest expense. All else equal, a company with higher residual income should be associated with higher valuations as it is creating value by generating more income than its cost of obtaining capital. Assuming a residual income of zero in the long run may make sense because if a company has a high ROE, other competitors will be enticed to enter the marketplace which will lower abnormal returns.

DISCLAIMER: Although I have taken great care to check all of the calculations, I am not a qualified financial advisor or accountant and you should not use this video to substitute financial advice. Make sure you talk to your own advisor before you use this model to make any financial decisions. Please do not rely solely on this model to guide your investment decisions.

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Overview: (0:00)
Assumptions: (1:00)
Creating the Residual Income Model: (2:41)
Implied Share Price: (6:11)