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The Use of Valuation Models by UK Investment Analysts

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  • Shahed Imam
  • Richard Barker
  • Colin Clubb
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    Abstract

    This paper examines the use of valuation models by UK investment analysts. The study is based on, first, semi-structured interviews with 35 sell-side analysts from 10 leading investment banks and with 7 buy-side analysts from 3 asset management firms and, second, content analysis based on 98 equity research reports for FTSE-100 companies covered by the sell-side interviewees. We observe that analysts perceive the discounted cash flow (DCF) (and to some extent 'sophisticated' models in general) to have become significantly more important than prior survey evidence suggests, although we also find the (somewhat paradoxical) continued importance of 'unsophisticated' valuation multiples, notably the price/earnings ratio (PE). We find perceived limitations in the technical applicability of the DCF, which cause analysts to rely in practice upon valuation multiples and subjective judgement of whether the market price 'feels right'. We also find that contextual factors, notably the analysts' need for their research to be credible to buy-side clients, cause the use of subjective, unsophisticated methods of valuation to be played down. Given the inherent flexibility of the DCF model, coupled with its ostensible credibility, it becomes the natural vehicle for conveying the analyst's research, even though it is very rarely relied upon to determine target prices and investment recommendations. We conclude that, while the literature has focused on the technical merits of alternative valuation models, analysts' actual usage of valuation models also requires an understanding of social and economic context and motivations.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/09638180802016650
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal European Accounting Review.

    Volume (Year): 17 (2008)
    Issue (Month): 3 ()
    Pages: 503-535

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    Handle: RePEc:taf:euract:v:17:y:2008:i:3:p:503-535

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    Cited by:
    1. Imam, Shahed & Chan, Jacky & Shah, Syed Zulfiqar Ali, 2013. "Equity valuation models and target price accuracy in Europe: Evidence from equity reports," International Review of Financial Analysis, Elsevier, vol. 28(C), pages 9-19.
    2. Jing Wang & Jim Haslam & Claire Marston, 2011. "The appraisal of ordinary shares by Chinese financial analysts," Asian Review of Accounting, Emerald Group Publishing, vol. 19(1), pages 5-30, May.
    3. Malcolm Beynon & Mark Clatworthy, 2013. "A fuzzy-based approach to residual income equity valuation," Review of Quantitative Finance and Accounting, Springer, vol. 40(4), pages 675-690, May.

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