An Improved Method for Valuing Mature Companies and Estimating Terminal Value

The theory underlying Discounted cash flow (DCF) models is uncontroversial in academia, the economic intuition behind them is straightforward, and the mathematics reassuringly simple. Nevertheless, in practice, they are applied inconsistently with very different valuation results. Because of the assumed infinite life (“going concern”) of a business enterprise, DCF models implicitly assume the ability to forecast future cash flows forever. This forces analysts to make assumptions about the terminal period using simplistic metrics such as P/E or EV/EBITDA to estimate terminal values or to embed a perpetual stream of excess profitability and value creation in the terminal period. The author offers an uncomplicated alternative to these unrealistic assumptions. The first step is to introduce an adjustable fade rate called f. A fade rate of 100% brings about immediate convergence, and a fade rate of 0% specifies no fade and perpetual excess profitability. The notion that excess profits get competed away over time can be modeled by assuming that the spread of (ROIC ‐ r) fades to zero and that economic profit dissipates. Intrinsic value is very sensitive to the fade rate assumption and this helps explain the risk premium for quality stocks. The risk of owning quality stocks is that they lose their economic moat and competitive advantage. An adjustable fade rate provides an excellent means to value the effect of profitability attenuation in a DCF model.     

The effect of non-recurring items on analysts’ earnings forecasts

This article discusses the effects of non-recurring profits and losses on statement users’ decision-making processes from the perspective of securities analysts. We examine the relationship between analysts’ forecast revisions and firms’ non-recurring earnings. We find that 1) non-recurring gains and losses can influence analysts’ earnings forecast revision; 2) compared with non-recurring items resulting from policy changes, analysts are more concerned about those attributed to changes in business scope; 3) if listed companies use non-recurring items to turn losses into gains during earnings management, it will weaken the effects of non-recurring items on analysts’ earnings forecast revision. The results suggest that non-recurring items that result from changes in business scope incorporate information that users need for the future operation of the business. This article verifies the information relevance of non-recurring items and provides evidence for the necessity of non-recurring item disclosure.     

Analysts’ pre-tax income forecasts and the tax expense anomaly

This paper examines whether analysts’ pre-tax income forecasts mitigate the tax expense anomaly documented by Thomas and Zhang (J Account Res 49:791–821, 2011). They find that seasonal changes in quarterly income tax expense are positively related to future returns after controlling for the earnings surprise and conclude that investors underreact to value-relevant information in tax expense. When analysts issue both earnings and pre-tax income forecasts, they implicitly provide a forecast of income tax expense. We posit that this implicit forecast helps investors recognize the persistence of current tax expense surprise for future earnings. Accordingly, we expect that mispricing of tax expense will be less severe for firms with earnings and pre-tax income forecasts. As expected, we find that the presence of pre-tax income forecasts significantly weakens the positive relation between tax expense surprise and future returns, consistent with analysts’ implicit forecasts of tax expense mitigating the tax expense anomaly.     

Measure for Measure: The Relation between Forecast Accuracy and Recommendation Profitability of Analysts

We examine the contemporaneous relation between earnings forecast accuracy and recommendation profitability to assess the effectiveness with which analysts translate forecasts into profitable recommendations. We find that, after controlling for expertise, more accurate analysts make more profitable recommendations, albeit only for firms with value‐relevant earnings. Next, we show that conflicts of interest from investment banking activities affect the relation between accuracy and profitability. In the case of buy recommendations, more accurate forecasts are associated with more profitable recommendations only for the nonconflicted analysts. For hold recommendations, higher levels of accuracy are associated with higher levels of profitability for conflicted analysts, provided these recommendations are treated as sells. Finally, we find that regulatory reforms aimed at mitigating analyst conflicts of interest appear to have improved the relation between accuracy and profitability. Specifically, the integrity of buy and hold recommendations has improved and the change is more pronounced for analysts expected to be most conflicted.     

THE ASSOCIATION BETWEEN ANALYSTS’ FORECAST REVISIONS AND EARNINGS COMPONENTS: THE EVIDENCE OF FRS 3

This study examines whether the earnings components as required by FRS 3 help UK analysts to predict firms’ earnings changes by investigating the statistical association between analysts’ forecast revisions and firms’ unexpected earnings components. I find that analysts’ forecast revisions made in different time horizons are consistently associated with unexpected earnings components as required by FRS 3. UK analysts are able to incorporate current-year unexpected earnings components into their current and future earnings forecasts even before firms officially release this information. However, empirical results also show that current-year unexpected earnings components are not fully incorporated into analysts’ forecasts of future earnings. Analysts appear to wait for more information releases regarding firms’ future earnings and delay their revisions of future earnings forecasts. This is consistent with the evidence that the cumulative revisions of current earnings forecasts are generally associated with prior-year unexpected earnings components, and the association appears to be stronger as time progresses. Overall, this study provides evidence suggesting that the earnings components as required by FRS 3 help UK analysts to identify firms’ permanent and transitory earnings changes over different forecast horizons. This study also provides strong evidence supporting the informativeness of earnings components for analysts’ forecasts and the information set perspective of FRS 3 that highlights the importance of earnings components in predicting a reporting entity’s future performance.     

Forecast accuracy and stock recommendations

We examine whether it is profitable to trade according to the recommendations of analysts who made accurate earnings forecasts in a prior year. Prior research has shown that analysts who made the most accurate earnings forecasts in the current period also made the most profitable recommendations during that period. Unfortunately, our research shows that these accurate forecasters cannot be identified on the basis of their track record. While there is statistically significant evidence that forecasting ability is persistent, it is not sufficient to generate profitable stock recommendations in the future. We also attempted to identify superior analysts with respect to the combination of forecast accuracy and recommendation profitability. Even with this finer segmentation of analysts there is no difference in their ability to make profitable recommendations in the future. Furthermore, regardless of forecasting ability, analysts are pre-disposed to recommend stocks with low book-to-market ratios and positive price momentum. This bias may impede their ability to make profitable recommendations.     

The role of analyst forecasts in the momentum effect

We evaluate the extent to which sell-side equity analysts can facilitate market efficiency when there is increasing uncertainty about a stock's future value. The prevalence of the 52-week-high momentum anomaly, that can be largely attributed to information uncertainty, provides a setting for examining the value and timing of analysts' earnings forecast revisions. Our study finds that analysts can provide value-relevant signals to investors by picking up indicators of momentum. The ability to identify under or over-valued stocks suggests that analysts are important information intermediaries in the price-continuation momentum effect. However, we also observe pervasive asymmetric reaction to good and bad news throughout our study that is consistent with incentive-driven reporting and optimistic biases. Nevertheless, analysts' forecast revisions are informative at different stages to re-establish stock prices back to their fundamental valuation.     

Are inter-segment revenues informative about future performance?

This study investigates the degree to which a specific component of segmental disclosure, intersegment transactions, informs future segment-level and firm-level profitability. By using segment data reported under the FAS No. 131 regime, we find a positive association between intersegment revenues and one-year-ahead segment operating profits; this association is weakened by agency costs but not proprietary costs. We also find that the aggregate intersegment revenue reported by a firm is positively associated with future firm-level earnings. However, analysts seem to underreact to information in aggregate intersegment revenue.     

An analyst by any other surname: Surname favorability and market reaction to analyst forecasts

We find that forecast revisions by analysts with more favorable surnames elicit stronger market reactions. The effect is stronger among firms with lower institutional ownership and for analysts with non-American first names. Following the 9/11 terrorist attacks, and France and Germany's opposition to the Iraq War, revisions by analysts with Middle Eastern and French or German surnames, respectively, generated weaker market reaction. Surname favorability is not associated with forecast quality, but it has complementary effects with forecast performance on analysts’ career outcomes. Surname favorability mitigates under-reaction to forecast revisions. These findings are distinct from the effects of ethnic, cultural proximity, or in-group bias.     

When does analyst reputation matter? Evidence from analysts’ reliance on management guidance

We investigate the joint effects of analyst reputation, uncertainty and guidance news valence on analysts’ reliance on management guidance. We find that, compared to less reputable analysts, reputable analysts rely less on guidance when they issue earnings forecasts. This analyst reputation effect is stronger when earnings and information uncertainty are higher or when the guidance contains good news. Further analysis suggests that both reputable and less reputable analysts sacrifice their forecast accuracy when they rely less on guidance; however, reputable analysts are compensated to a greater extent by the increased informativeness of their forecasts. Finally, we find that analysts’ future career advancement is enhanced when their reliance is low.     

Incremental Voluntary Disclosure on Corporate Websites,Determinants and Consequences

This study analyses the determinants and consequences of internet financial reporting (IFR). Our evidence indicates that firms use the internet to report complementary information on firm background, management forecasts, intangible assets and on social and environmental issues. Our results indicate that the decision to provide additional voluntary financial disclosures through corporate websites is mostly influenced by share turnover, the future profitability of the firm and the level of competition in the industry. Last, we find that the extent of voluntary disclosure on corporate websites is related positively to forecast accuracy, and negatively to the dispersion of analysts forecasts, suggesting that such disclosures provide useful information to analysts.     

Financial Analysts and the False Consensus Effect

Social psychologists have documented a tendency for people to overestimate their similarity to others. I investigate whether financial analysts' forecast errors are consistent with this bias. I model the bias by assuming analysts overestimate the correlation of the private signals they receive about a firm's future earnings. My model predicts a positive relationship between (i) the likelihood of an analyst's revised forecast being too close to his earlier forecast and (ii) the number of analysts issuing forecasts during the time interval between his two forecasts. I empirically confirm this prediction and consider several alternative explanations.     

Analyst underreaction and the post-forecast revision drift

The post-forecast revision drift (PFRD), the phenomenon of delayed stock price reactions to analyst forecast revisions, is a well-documented market anomaly. Prior research attributes PFRD to underreaction by investors to analyst forecast revisions. This study investigates the role of the analyst forecast revision process itself in the PFRD anomaly. Using a large sample of US firms, we confirm prior findings of a positive serial correlation (momentum) in individual analysts’ revisions to their earnings forecasts and, based on both indirect and direct tests, document a positive association between this momentum and PFRD. Further analyses reveal that both the forecast revision momentum and PFRD vary in similar ways with respect to the nature of the news driving the revisions and the information environment. Collectively, our findings show that underreaction by individual analysts in the forecast revision process is an important contributor to the PFRD phenomenon.     

Seeing is believing: analysts’ corporate site visits

This study examines the impact of corporate site visits on analysts’ forecast accuracy based on a sample of such visits to Chinese listed firms during 2009–2012. We find that analysts who conduct visits (“visiting analysts”) have a greater increase in forecast accuracy than other analysts. Consistent with the notion that site visits facilitate analysts’ information acquisition through observing firms’ operations, we find that the results are stronger for manufacturing firms, firms with more tangible assets, and firms with more concentrated business lines. Moreover, we find that the effect of a site visit is greater when the site visit is an analyst-only visit, when the current visit is preceded by fewer visits, and when visiting analysts are based far from the visited firms. Furthermore, we find that site visits partially mitigate nonlocal analysts’ information disadvantage. Collectively, these results indicate that site visits are an important information acquisition activity for analysts.     

SECURITY ANALYST FORECASTS AND THE EARNINGS YIELD ANOMALY

This paper tests for existence of a positive relationship between the earnings yield anomaly and the earnings forecast error (EFE) effect. The earnings yield anomaly recognizes that stocks with low price-earnings ratios produce positive risk-adjusted returns. The EFE effect refers to the positively related stock price response to differences in reported earnings per share (EPS) and the EPS previously forecast by security research analysts. The within group method is used in order to remove the effect of the EFE. Empirical research findings based on 1979-1988 data, indicate that the EFE effect does not account for the earnings yield anomaly.     

上市公司综合盈利水平与股票收益

本文基于2000-2017年上市公司的财务及股票交易数据,研究了上市公司综合盈利水平与股票收益之间的关系。我们使用目前资产定价文献中较新的偏最小二乘法和组合预测法,从12个衡量公司盈利能力的指标中提取了一个测度上市公司综合盈利水平的指标。研究结果显示,上市公司综合盈利水平能够显著预测未来股票收益。使用单因子偏最小二乘法、取12个月斜率的平均值构造的综合盈利水平最有效,以其构建的多空对冲投资组合能产生15%的年平均收益,夏普比率达到0.75。与此对应,组合预测法提取的上市公司综合盈利水平的预测能力稍低,但依然显著。在控制了其他公司特征变量后,综合盈利水平对于股票收益的解释能力依然稳健。本文还从经济机制的角度出发,探讨了综合盈利水平对收益的预测来源。我们发现,上市公司综合盈利水平与股票预期回报的正向关系在投资摩擦更低的组中更高,而在错误定价程度更高的组通常更低。这些结果支持了基于投资摩擦的Q理论,而与行为金融的错误定价理论相悖。     

超预期股本扩张与分析师每股盈余预测

卖方分析师的每股盈余预测在实证文献中被广泛使用。该指标同时依赖于分析师对目标公司未来净利润的预测和对目标公司未来股本数量的预测。因此,如果在分析师发布预测后,目标公司的股本数量发生超出分析师预期的扩张,则每股盈余预测将无法代表分析师对目标公司未来基本面的预测。本文构建了“调整后每股盈余预测”指标,该指标可剔除超预期股本扩张对每股盈余预测的影响,真实反映分析师对目标公司未来基本面的预测。本文应用该指标,在两个具体的实证研究场景中证明了,忽略超预期股本扩张的影响可能得出错误的实证结论。本文还进一步指出了三个忽略超预期股本扩张的影响可能导致错误实证结果的研究场景。     

The Effect of CEO Extraversion on Analyst Forecasts: Stereotypes and Similarity Bias

In an experiment with professional analysts, we study their reliance on CEO personality information when producing financial forecasts. Drawing on social cognition research, we suggest analysts apply a stereotyping heuristic, believing that extraverted CEOs are more successful. The between‐subjects results with CEO extraversion as treatment variable confirm that analysts issue more favorable forecasts (earnings per share, long‐term earnings growth, and target price) for firms led by extraverted CEOs. Increased forecast uncertainty leads to even stronger stereotyping. Additionally, personality similarity between analysts and CEOs has a large effect on financial forecasts. Analysts issue more positive forecasts for CEOs similar to themselves.     

超预期股本扩张与分析师每股盈余预测

卖方分析师的每股盈余预测在实证文献中被广泛使用。该指标同时依赖于分析师对目标公司未来净利润的预测和对目标公司未来股本数量的预测。因此,如果在分析师发布预测后,目标公司的股本数量发生超出分析师预期的扩张,则每股盈余预测将无法代表分析师对目标公司未来基本面的预测。本文构建了“调整后每股盈余预测”指标,该指标可剔除超预期股本扩张对每股盈余预测的影响,真实反映分析师对目标公司未来基本面的预测。本文应用该指标,在两个具体的实证研究场景中证明了,忽略超预期股本扩张的影响可能得出错误的实证结论。本文还进一步指出了三个忽略超预期股本扩张的影响可能导致错误实证结果的研究场景。     

Do analysts who understand accounting conservatism exhibit better forecasting performance?

This study investigates the performance of analysts when they match the asymmetric timeliness of their earnings forecast revisions (i.e., asymmetric forecast timeliness) with the asymmetric timeliness of firms’ reported earnings (i.e., asymmetric earnings timeliness). We find that better timeliness‐matching analysts produce more accurate earnings forecasts and elicit stronger market reactions to their forecast revisions. Further, better timeliness‐matching analysts issue less biased earnings forecasts, more profitable stock recommendations and have more favorable career outcomes. Overall, our results indicate that analysts’ ability to incorporate conditional conservatism into their earnings forecasts is an important reflection of analyst expertise and professional success.