We build and test a Bayesian model that shows how investors revise their earnings persistence expectations after dividend announcements. When dividend changes confirm preceding earnings changes, our model predicts inverse u‐shaped investor revisions conditional on the prior expectations for noisy dividend signals. As the dividend signal becomes more informative, our model predicts that investor revisions will become more skewed converging to a monotonically decreasing relation for perfectly informative dividend signals. When dividend changes contradict preceding earnings changes, our model predicts u‐shaped investor revisions. In empirical tests, we find results generally consistent with our model predictions.

Previous empirical studies derive the standard equity valuation models (i.e., DDM, RIM, and DCF model) while assuming that ideal conditions, such as infinite payoffs and clean surplus accounting, exist. Because these conditions are rarely met, we extend the standard models by following the fundamental principle of financial statement articulation. We then empirically test the extended models by employing two sets of forecasts: (1) the analyst forecasts provided by Value Line, and (2) the forecasts generated by cross‐sectional regression models. The main result is that our extended models yield considerably smaller valuation errors. Moreover, by constructing these models, we obtain identical value estimates across the extended models. By reestablishing empirical equivalence under nonideal conditions, our approach provides a benchmark that enables us to quantify the errors caused by individual deviations from ideal conditions and thus to analyze the robustness of the standard models. Finally, by providing a level playing field for the different valuation models, our findings have implications for other empirical approaches, for example, estimating the implied cost of capital.