Ratio Analysis and Equity Valuation: From Research to Practice

Financial statement analysis has traditionally been seen as part of thefundamental analysis required for equity valuation. But the analysis has typicallybeen ad hoc. Drawing on recent research on accounting-based valuation, this paperoutlines a financial statement analysis for use in equity valuation. Standardprofitability analysis is incorporated, and extended, and is complemented with ananalysis of growth. An analysis of operating activities is distinguished from theanalysis of financing activities. The perspective is one of forecasting payoffs to equities. So financial statement analysis is presented as a matter of pro formaanalysis of the future, with forecasted ratios viewed as building blocks offorecasts of payoffs. The analysis of current financial statements is then seen asa matter of identifying current ratios as predictors of the future ratios thatdetermine equity payoffs. The financial statement analysis is hierarchical, withratios lower in the ordering identified as finer information about those higher up.To provide historical benchmarks for forecasting, typical values for ratios aredocumented for the period 1963–1999, along with their cross-sectionalvariation and correlation. And, again with a view to forecasting, the time seriesbehavior of many of the ratios is also described and their typical long-run,steady-state levels are documented.     

Analysts Earnings Forecasts and the Roles of Earnings and Book Value in Equity Valuation

This study examines the effect of the degree of association between current earnings and expected future earnings on the relative importance of earnings and book value for explaining equity price. Consensus analysts forecasts of one-year-ahead earnings are used to proxy for expected future earnings and are compared to reported current earnings to measure the degree of the association. We find that the value-relevance of current earnings negatively correlates with the extent to which consensus analysts forecasts deviate from current earnings. We also find that the incremental explanatory power of book value for equity price positively correlates with this measure. These results remain robust after controlling for factors known to be affecting the value-relevance of earnings such as negative earnings and the earnings-to-book ratio. Our results also show that this analysts' forecast-based measure of `earnings persistence' dominates historical earnings variance in explaining cross-sectional variations in the value-relevance of earnings and book value.     

An International Analysis of Historical and Forecast Earnings in Accounting-Based Valuation Models

Abstract:  In this paper we examine whether the valuation properties of historical accounting amounts, namely earnings and equity book value, differ from those of forecasted earnings for firms in 17 developed countries classified into six accounting regimes. We compare the performance of a historical model and a residual-income forecast model for explaining security prices. The historical model uses the book value of equities and actual historical earnings and the forecast model uses the book value of equities and analysts' forecasts of earnings in the residual income for estimating the intrinsic value of the firm. The results suggest that book values, historical earnings or forecasted earnings are value relevant in most regimes and countries examined. The forecast model offers significantly greater explanatory power for security prices than the historical model in the Anglo-Saxon and North American countries, Japan, Germany, and three Nordic countries. The explanatory power of the historical model is similar to that of the forecast model in the Latin countries, two Nordic countries, and Switzerland. We find that the forecast model performs similarly to the historical model where financial analysts' forecasts are noisy and analysts are less active. Further results indicate that the forecasted earnings are more value-relevant than the historical earnings in countries with stronger investor protection laws, less conservative GAAP, greater income conservatism, and more transparent accounting systems.     

Future Stock Performance of Oil and Gas Firms Conditional on the Imputed Value of Reserves

Review of Quantitative Finance and Accounting - Harris and Ohlson (1990) provide evidence suggesting market inefficiencies in the pricing of oil and gas firms in the 1979–1984 period. This...     

Equity valuation: A survey of professional practice

This paper reports the results of a scientific survey of the equity valuation practices of CFA Institute members with equity analysis job responsibilities. Using an instrument designed to minimize biases in prior valuation surveys and sampling a larger group than in previous studies (13,500 investment professionals, resulting in 1,980 valid completed questionnaires), this paper documents professional practices in the selection of equity valuation approaches, including specific model variations and key input preferences. Important differences in practice were observed across geographies and employer firm types.     

Valuation Weights,Linear Dynamics and Accounting Conservatism: An Empirical Analysis

Residual income models provide an important theoretical link between equity valuation and financial statement variables. While various researchers have developed models of how accounting policy impacts on the structure of these models, empirical support for these models is at best weak and frequently contradictory. In this paper, we develop an analytical model, which identifies the dependency between valuation weights in residual income models and the associated structure of earnings information dynamics and accounting conservatism. In contrast to many earlier studies, we find strong evidence of conservatism in our reformulation of the linear dynamics. We proceed to test our predictions of the dependency of the weights on two measures of conservatism, the conventional measure of price‐to‐book ratio and the recent measure of a C‐Score index developed by Khan and Watts (2009) and find that the empirical results accord well with our theoretical predictions in the case of the former but not the latter measure.     

Oil Risk Exposure: The Case of the U.S. Oil and Gas Sector

We estimate oil price risk exposures of the U.S. oil and gas sector using the Fama‐French‐Carhart's four‐factor asset pricing model augmented with oil price and interest rate factors. Results show that the market, book‐to‐market, and size factors, as well as momentum characteristics of stocks and changes in oil prices are significant determinants of returns for the sector. Oil price risk exposures of U.S. oil and gas companies in the oil and gas sector are generally positive and significant. Our study also finds that oil price risk exposures vary considerably over time, and across firms and industry subsectors.     

Security Choice, Information Effects and Firm Characteristics: A Factor Analytic Approach

Abstract:   We examine the marginal choice between debt and equity securities using a factor analytic approach. This data reduction property eliminates the need to select the one best variable to proxy for a particular theoretical construct. Our results reinforce numerous existing findings using traditional methods and suggest both static tradeoff and asymmetric information based considerations are relevant in determining security choice. Two new results are presented related to the accounting liquidity of the firm. First, the preference for equity is increasing with liquidity as suggested by the window of opportunity hypothesis. Secondly, the market response to equity issuance announcements is inversely related to the liquidity of the firm. Profitability and growth measures support Jensen's (1986) agency cost of free cash flow as a potential explanation for the second finding.     

Conservatism, Growth and the Role of Accounting Numbers in the Fundamental Analysis Process

I evaluate the effects of conservative accounting for research and development (R&D) and past growth in R&D on: (1) the relation between aggregate earnings (deflated by price) and contemporaneous stock return, and (2) the association between estimates of value derived from the residual income valuation model (i.e., RIV estimates) and equity market value. I show that the conservative treatment of R&D affects the earnings/return relation only for firms that experience high growth in R&D during the return interval of interest. I also demonstrate that the effect of conservative accounting for R&D on the association between RIV estimates and equity market values is increasing in past growth in R&D.This revised version was published online in August 2005 with a corrected cover date.     

A Finite Difference Approach to the Valuation of Path Dependent Life Insurance Liabilities

This paper sets up a model for the valuation of traditional participating life insurance policies. These claims are characterized by their explicit interest rate guarantees and by various embedded option elements, such as bonus and surrender options. Owing to the structure of these contracts, the theory of contingent claims pricing is a particularly well-suited framework for the analysis of their valuation.The eventual benefits (or pay-offs) from the contracts considered crucially depend on the history of returns on the insurance company's assets during the contract period. This path-dependence prohibits the derivation of closed-form valuation formulas but we demonstrate that the dimensionality of the problem can be reduced to allow for the development and implementation of a finite difference algorithm for fast and accurate numerical evaluation of the contracts. We also demonstrate how the fundamental financial model can be extended to allow for mortality risk and we provide a wide range of numerical pricing results.     

Liability Valuation and Debt Defeasance: A Cash-Flow Exit-Price (CaFE) Approach

This paper reviews the arguments of Chambers with respect to liability measurement in his continuously contemporary accounting (CoCoA) system and the views of his critics are summarized and discussed. The paper then examines the issue of laibility valuation and in-substance debt defeasance in the context of historic-cost accounting. A specific illustration is provided showing how an in-substance debt-defeasance arrangement would be reported under a CaFE system. It is concluded that stating debt at its exit price would provide useful information and could reduce the incentives for firms to enter into in-substance debt-defeasance arrangements.     

Stock Market Valuation, Profitability and R&D Spending of the Firm: The Effect of Technology Mergers and Acquisitions

Abstract:  In this paper, we investigate whether a firm can enhance the effect of its R&D spending on its current market value and future profitability through technology-oriented M&As. On the basis of an analysis of 1,879 M&As, we find that when a technology firm acquires another technology firm, the magnitude of the stock price response to the R&D spending of an acquirer increases by 107% in the year of the M&A. In contrast, we find no such increase in the stock price response to the R&D spending of a non-technology acquirer. We also find that technology acquirers are more successful in converting their R&D spending into positive future profitability than non-technology acquirers. Our results are robust for different alternative specifications of our model and when various firm differences are controlled for.     

Risk Transmission from Oil and Natural Gas Futures to Emerging Market Mutual Funds

This study evaluates the impacts of energy markets on emerging market mutual funds (EMMFs). In particular, we investigate the volatility transmission between these funds and the oil and natural gas prices. The findings suggest significant risk spillover from the energy markets to EMMFs. Furthermore, we find a large number of EMMFs’ risk transmitting to oil prices and almost all of the EMMFs’ risk transmitting to natural gas prices. By dividing the sample into two (before and after 2008), we find the EMMFs’ influence on the oil market decreasing after this turbulent period. Our results have important implications for mutual fund managers and investors.     

银行监管与企业融资的跨国实证分析

依据世界银行对各国银行监管与微观企业调查的跨国数据,运用实证分析方法,考量巴塞尔协议三大银行监管手段对企业融资的影响。结果发现：资本充足率要求与私营部门监测均会降低融资可得性,且对中小型企业的影响更大;而政府部门监管权力能提高企业融资可得性。鉴于此,监管机制设计应充分考虑不同政策的相互影响,特别是对中小型企业融资的冲击,慎重调整资本充足率与对私人监测程度的监管要求,妥善应用政府监测程度监管权力来实现金融稳定与企业融资的双赢,增强金融服务实体经济能力。     

美国油气法捕获规则的形成与发展——兼及对中国立法的启示

美国油气法捕获规则系判例法确立的一项产权制度,从野生动物捕获规则移植而来.该规则对美国石油天然气产业发展起到了极大的促进作用,但同时也产生了过度开采、资源浪费等问题.美国各州相继通过颁布强制联营规则、井间距规则、禁止浪费规则等一系列配套立法对油气法捕获规则进行修改和限制,提高了油气开采效率,保证了油气产业的有序发展.借鉴美国油气法捕获规则的立法与司法经验,我国未来石油天然气立法应当制定油气资源矿业权重叠情形下的联合开发规则,同时应当完善石油天然气上游产业市场准入制度和油气开采监管制度.     

Relative Value Relevance of the Successful Efforts and Full Cost Accounting Methods in the Oil and Gas Industry

This paper examines the value relevance of two alternative accounting methods for exploration and development (E&D) expenditures for oil and gas firms. I find that full cost (FC) accounting data is more value-relevant than successful efforts (SE) accounting data. Further analysis reveals that the smooth earnings provided by the FC method contributes to the higher value relevance of the FC method. This study concludes that a policy of full capitalization of expenditures with uncertain future economic benefits better summarizes information relevant to investors relative to a policy of partial capitalization.     

A Simultaneous Equations Analysis of Analysts' Forecast Bias, Analyst Following, and Institutional Ownership

In this paper we use a simultaneous equations model to examine the relationship between analysts' forecasts, analyst following, and institutions' investment decisions. Estimates of our three equation model using US data indicate that higher institutional demand leads to greater optimism among analysts and lower analyst following. At the same time, institutional demand increases with increasing optimism in analysts' forecasts but decreases with analyst following. We also investigate firm characteristics as determinants of analysts' and institutions' decisions. Empirical estimates of the effects of these characteristics indicate that agency‐driven behavioral considerations are significant.     

Effects of Firm Size,Financial Leverage and R&D Expenditures on Firm Earnings: An Analysis Using Quantile Regression Approach

As documented in the literature, the effects of firm size, financial leverage, and R&D expenditures on firm earnings are inclusive. Our hypothesis is that the inconsistent empirical results of such effects may be driven by the regression models implemented in data analysis. Using the quantile regression (QR) approach developed by Koenker and Basset (1978), this study analyses S&P 500 firms from 1996 to 2005. We find that the effects of firm size, financial leverage and R&D expenditures on firm earnings differ considerably across earnings quantiles. Comparing the results from the QR approach with those from the ordinary least squares (OLS) and least absolute deviation (LAD) methods, this study further explains the puzzling relationship between firm size, financial leverage, R&D expenditures and firm earnings.     

A Comparative Analysis of Auditor, Manager and Financial Analyst Interpretations of SFAS 5 Disclosure Guidelines

This study examines empirically whether financial analysts (users), as well as managers (preparers) and external auditors ascribe different interpretations to the SFAS 5 disclosure criteria. We find: (1) financial analysts are, on average, more conservative than managers and auditors in their numerical interpretations of both the 'remote' and 'probable' verbal phrases; (2) managers and auditors share very similar numerical interpretations of these verbal phrases; (3) audit partners' numerical interpretations of the 'remote' region are between those of managers and users, whereas audit managers align their numerical interpretations with those of managers. One danger is that preparers of financial statements may omit loss contingency information that users consider valuable.     

The Impact of Corporate Governance on the Relationship Between Fundamental Information Analysis and Stock Returns

This study investigates whether corporate governance affects the impact of the relationship between fundamental signals and stock returns using Taiwanese data. The study employs the endogenous switching model (ESM) of Hu and Schiantarelli (1998), which combines the response equation and governance index equation simultaneously. We divide the sample into strong and weak governance regimes. Our results suggest that stock returns respond differently in different governance regimes. The beneficial response is greater in the strong governance regime than in the weak one, suggesting that it is worth improving governance for firms.