Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth |
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Authors: | Alexander Nekrasov Maria Ogneva |
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Institution: | (1) University of California, Irvine, Irvine, CA 92697, USA;(2) Stanford University, Stanford, CA 94305, USA |
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Abstract: | A growing body of literature in accounting and finance relies on implied cost of equity (COE) measures. Such measures are
sensitive to assumptions about terminal earnings growth rates. In this paper we develop a new COE measure that is more accurate
than existing measures because it incorporates endogenously estimated long-term growth in earnings. Our method extends Easton
et al. (J Account Res, 40, 657–676, 2002) method of simultaneously estimating sample average COE and growth. Our method delivers COE (growth) estimates that are significantly positively associated with future realized
stock returns (future realized earnings growth). Moreover, the predictive ability of our COE measure subsumes that of other
commonly used COE measures and is incremental to commonly used risk characteristics. Our implied growth measure fills the
void in the earnings forecasting literature by robustly predicting earnings growth beyond the five-year horizon. |
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