Explain where residual income models are strong and weak and argue for using one to value a firm's common stock

Residual income models have clear strengths: terminal values are a smaller share of total value, they use readily available accounting data, they work for companies that pay no dividend or have negative free cash flow, and they focus on economic profitability rather than accounting profit alone. Their weaknesses are that they depend on accounting data that may be distorted or managed, they assume a clean surplus relation in which book value changes only through earnings and dividends, and they may need adjustments for items taken directly to equity. The model suits companies without dividends, with negative expected free cash flow or with very uncertain terminal values. It is a poor fit for companies whose reported book values are unreliable.