Residual income valuation and the justified P/TBV
Profit above the cost of equity, on tangible book.
By Surojit Chakraverti, founder of L3VLUP and an investor running a long-short healthcare and technology equities strategy.
On this subject: residual income valuation and the justified p/tbv.Updated 30 October 2026
Part of project finance and infrastructure models, with the models, labs and guides around it.
What it does
The way to value a business whose debt is its raw material. Residual income is net income less the cost of equity on opening tangible book: the profit above what shareholders require. Equity value is tangible book today plus the present value of every year’s residual income, with a terminal value for the years after the forecast. At steady state this collapses to one line, the justified price to tangible book, (ROTE - g) / (cost of equity - g). Discounting the distributions the capital plan allows gives the same answer when book moves only by profit and payouts.
Where it lives
The same schedule in each model that carries it, with the rows to open. Open a model in the browser, go to the sheet, and click the lines.
- Assumptions, rows 119–123: Risk-free rate, Equity beta, Equity risk premium, Terminal return on tangible equity (ROTE)…
- Valuation, row 6: Cost of equity
- Valuation, rows 9–22: Tangible equity, Net income, Less the cost of opening tangible equity, Residual income…
- Valuation, rows 25–27: Justified P/TBV at the terminal ROTE, Value per share at the justified multiple, Justified P/TBV on the FY1E return
- Valuation, rows 30–38: Dividends and buybacks, Present value of distributions, Terminal value: FY5E tangible equity at the justified multiple, Equity value from distributions…
- Valuation, rows 41–47: Tangible equity growing at the terminal rate, Residual income at the terminal ROTE, Distributions at the terminal ROTE, Residual income value…
- Forecast, rows 49–50: Cost of equity (editorial, every case), Growth of residual income after FY2030E (editorial, every case)
- Valuation, rows 6–21: Net income, Equity at the start of the year, Equity charge: cost of equity x opening equity, Residual income: net income - equity charge…
What a reviewer looks for
- A DCF of free cash flow to the firm for a bank, where enterprise value has no meaning.
- Residual income charged on closing rather than opening book.
- A terminal ROTE below the cost of equity with a multiple above one.
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