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Does Valuation Model Choice Affect Target Price Accuracy?

Listed author(s):
  • Efthimios Demirakos
  • Norman Strong
  • Martin Walker

We investigate whether the choice of valuation model affects the forecast accuracy of the target prices that investment analysts issue in their equity research reports, controlling for factors that influence this choice. We examine 490 equity research reports from international investment houses for 94 UK-listed firms published over the period July 2002-June 2004. We use four measures of accuracy: (i) whether the target price is met during the 12-month forecast horizon (met_in); (ii) whether the target price is met on the last day of the 12-month forecast horizon (met_end); (iii) the absolute forecast error (abs_err); and (iv) the forecast error of target prices that are not met at the end of the 12-month forecast horizon (miss_err). Based on met_in and abs_err, price-to-earnings (PE) outperform discounted cash flow (DCF) models, while based on met_end and miss_err the difference in valuation model performance is insignificant. However, after controlling for variables that capture the difficulty of the valuation task, the performance of DCF models improves in all specifications and, based on miss_err, they outperform PE models. These findings are robust to standard controls for selection bias.

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

Volume (Year): 19 (2010)
Issue (Month): 1 ()
Pages: 35-72

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Handle: RePEc:taf:euract:v:19:y:2010:i:1:p:35-72
DOI: 10.1080/09638180902990630
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