Residual income valuation (RIV; also, residual income model and residual income method, RIM) is an approach to equity valuation that formally accounts for the cost of equity capital. Here, "residual" means in excess of any opportunity costs measured relative to the book value of shareholders' equity; residual income (RI) is then the income generated by a firm after accounting for the true cost of capital. The approach is largely analogous to the EVA/MVA based approach, with similar logic and advantages. Residual Income valuation has its origins in Edwards & Bell (1961), Peasnell (1982), and Ohlson (1995).^{[citation needed]}

The underlying idea is that investors require a rate of return from their resources – i.e. equity – under the control of the firm's management, compensating them for their opportunity cost and accounting for the level of risk resulting. This rate of return is the cost of equity, and a formal equity cost must be subtracted from net income. Consequently, to create shareholder value, management must generate returns at least as great as this cost. Thus, although a company may report a profit on its income statement, it may actually be economically unprofitable; see Economic profit. It is thus possible that a value deemed positive using a traditional discounted cash flow (DCF) approach may be negative here. RI-based valuation is therefore a valuable complement to more traditional techniques.

The cost of equity is typically calculated using the CAPM, although other approaches such as APT are also used. The currency charge to be subtracted is then simply

and

Using the residual income approach, the value of a company's stock can be calculated as the sum of its book value today (i.e. at time ${\displaystyle 0}$) and the present value of its expected future residual income, discounted at the cost of equity, ${\displaystyle r}$, resulting in the general formula:

Here various adjustments to the balance sheet book value may be required; see Clean surplus accounting.

More typically, the company is assumed to achieve maturity or "constant growth", at time ${\displaystyle m}$, and the below formulae are applied instead. (Note that the value will remain identical: the adjustment is a "telescoping" device). In the first step, analysts commonly employ the Perpetuity Growth Model to calculate the terminal value — although various, more formal approaches are also applied — which returns:

In the second step, the RI valuation is then: