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Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth

Author

Listed:
  • Alexander Nekrasov

    (University of California, Irvine)

  • Maria Ogneva

    (Stanford University)

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.

Suggested Citation

  • Alexander Nekrasov & Maria Ogneva, 2011. "Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth," Review of Accounting Studies, Springer, vol. 16(3), pages 414-457, September.
    • Handle: RePEc:spr:reaccs:v:16:y:2011:i:3:d:10.1007_s11142-011-9159-2
    DOI: 10.1007/s11142-011-9159-2
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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