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Emerging market stock valuation: new evidence from Peru
... 1. R 2 ajustado que debería ser superior a 0,70 para garantizar correlación significativa (Arana & Burneo, 2021). ...
... 2. De similar manera, se analizó multicolinealidad para evitar que dos variables expliquen el mismo fenómeno y diluyan el modelo (Arana & Burneo, 2021). ...
... 1. Adjusted R 2 that should be greater than 0.70 to guarantee a significant correlation (Arana & Burneo, 2021). ...
... 2. In a similar way, multicollinearity was analyzed to avoid that two variables explain the same phenomenon and dilute the model (Arana & Burneo, 2021). Finally, the model to be tested is the one proposed by Arana (2020) based on the following formula: ...
A common prerequisite in valuation analysis is the availability of temporal information on financial variables. Nevertheless, reduced size companies-representing more than 98% on current productive systems- fail to have available temporal information to estimate valuations. In this paper, we offer a procedure for estimating reduced size companies’ values under the hypothesis that spatial behaviour matters for valuations. With this aim, we present the theoretical background for this hypothesis and introduce a spatial proposal with a case study of industrial companies where the significant role of space on firms’ valuations is previously tested. This analysis shows the relevance of spatial information in firms’ valuation confirming the predictive capability of our approach applying the out of sample methodology
Orientation: A key objective of a company is to maximise shareholder wealth. Distribution of created wealth is achieved either through reinvestment in the company, which increases share value, or through dividend payouts. This encapsulates the dividend policy of a company. In order to realise a cash return, the former requires an investor to liquidate part of the investment, while the latter provides an immediate cash return.
Research purpose: The objective was to establish whether relationships exist between share price volatility and dividend policy for shares listed on the Johannesburg Stock Exchange Limited (JSE).
Motivation for the study: Dividend policy is an important consideration in the wealth creation process, particularly whether or not to distribute dividends to shareholders. Dividend policy is often structured to cater for shareholders’ expectations.
Research design, approach and method: Panel data analysis was employed on a sample of the top 40 JSE-listed shares from 2007 to 2016.
Main findings: The results indicated that the association between share price volatility and dividend yield is positive and significant but that between share price volatility and payout ratio is insignificant.
Practical/managerial implications: Dividends were proven to be relevant to shareholders and have an association with share price volatility.
Contribution/value-add: Dividend policy for the top 40 companies listed on the JSE is a contributor to share price volatility. In order to minimise share price volatility, managers of dividend-paying companies should structure the dividend policy to have consistent dividend payments but also able to reinvest excess cash within the company.
In this paper we investigate the importance of earnings quality as a determinant of cash holdings by companies, exploring among other factors the nature of earnings (positive or negative) and the level of financial disclosure, proxied by the market where firms are listed (Main or AIM-Alternative Investment Markets in the United Kingdom). Based on a sample covering the period of 1998-2015, we provide evidence that as earnings quality decreases, firms tend to hold more cash except when firms are facing losses in both Main and AIM markets. In addition, we document that information conveyed by earnings quality is a more important determinant of cash reserve levels for Main market than for AIM firms (where the level of financial disclosure and oversight is lower). Overall, our evidence suggests that cash balances are positively influenced by the presence of greater information asymmetries arising from poor earnings quality but also from the existence of lower levels of regulatory oversight and the occurrence of losses, both of which reduce the importance of earnings quality as a determinant of cash levels. Our results also imply that companies with higher levels of earnings opaqueness seem to benefit from having higher cash holdings so as to avoid dependence from costly external funding.
Market multiples are more often used than studied. Equity analysts, investment bankers and other practitioners widely use market multiples to estimate the value of companies. Nevertheless, literature about multiples is not as rich as the wide use of these valuation tools would suggest. This paper, focusing on European listed companies, investigates how multiples can be used in the valuation of cyclical companies, a much less investigated research topic. We test the accuracy of multiples to understand whether their performance in valuing cyclical companies is better, worse or equal to the performance found in prior studies, where both cyclical and non cyclical companies are analyzed without distinguishing between them. We also attempt to verify whether the way in which multiples are calculated significantly affects the accuracy of estimation. Our aim is to develop a valuation approach consistent with valuation theory and helpful in everyday practice.
This paper separately studies the impact of different kind of fiscal policy on the stock return stabilisation in the case of Indonesia. Using quarterly data over the period 2001-2013, we obtained that the discretionary and automatic stabilisation fiscal policy tend to induce the stock returns volatility. While the credible debt rule policy leads to decrease the volatility of stock returns, the deficit rule policy is found to be non-credible and does not have any effect. Accordingly, the lower ratio of government expenditure to GDP along with improving commitment tightly to the planned deficit ratio is a good signal for stabilising financial market.
The purpose of this article is to empirically examine the comparative accuracy of income oriented (Free cash flow to equity, Residual income model) and market oriented (Price to earnings multiple, Price to book value multiple and Price to sales multiple) valuation models for the Indian manufacturing industry, and propose a composite valuation model (CV) to explore whether combining value estimates may improve valuation accuracy. Data are drawn from a sample of 3756 Bombay Stock Exchange (BSE) listed manufacturing companies from 1997 to 2012. Findings from the empirically analysis indicate that residual income model is better than free cash flow to equity model under income oriented valuation model, whereas both Price to earnings multiple and Price to book value multiple are superior to Price to sales multiple and are equally likely under market oriented valuation model. Finally, the empirical findings suggest that CV provides better value estimates for Indian manufacturing industry. Further, lag of PE and profitability are the two probable determinants of prediction error of the model.
A literature review suggests eight empirical implementation issues to which practitioners should give increased attention. Implementation issues include how comparable firms are selected, the use of reported versus forecasted earnings, and the most suitable way of calculating averages. We identify a more effective way to handle each implementation issue in order to enhance the accuracy of valuation outputs. By synthesizing the main empirical findings and thereby identifying best practices when applying market multiples, we expect to help analysts, portfolios managers, and investment bankers make more informed decisions when accessing a firm's value. .
As an industry matures, company valuations shift from a revenue driven valuation to a profitability driven valuation. Despite operating in a relatively mature industry, companies in the enterprise resource planning (ERP) software segment are still influenced by revenue driven valuations. The nature of the industry, with low delivery costs and high personnel costs, and the on-going switch from packaged software revenues towards “as a service” revenues protect the importance of revenues in this segment. With the development of the sector, the valuation drivers (key operating performance indicators) shift from revenue growth to profitability. In the ERP software segment top line growth remains the key driver especially with emergence of the Internet of Things and the concept of “Industry 4.0”, where an increasing number of devices are interconnected and can communicate with each other. The article analyses through regression analysis the current revenue and operating profitability based valuation levels of thirteen publicly listed in the ERM software segments against several key operating performance indicators. The results of our research show that future expected revenue growth remains the most important key operating performance indicator and both revenue and profitability driven valuations remain relevant. These findings are especially important for investors in the ERM software segment which are looking to sell their companies or to raise additional capital.
The enterprise's market value is one of the main parameters characterizing the condition of the business entity, its development prospects and market position. It is an important criterion considered by managers and investors. Among the wide group of business valuation methods, multiple-based methods of valuation can be distinguished. Their undeniable advantage is the relative simplicity and speed of carrying out the process of valuation. An important condition for their application is a sufficiently developed and mature capital market.
The aim of the paper is to present the potential of the application of multiple-based methods in the valuation of real estate development companies. The analysis will be conducted on the basis of the experience of the Polish market.
Market multiples are a tool for estimation corporate value. These tools are expressed as temporal dynamics and differences in the markets, sectors, industries, firms. Despite their great practical application, a number of problems remains which continue to be debated. This article examines the explanatory power of multiples, and makes a comparison of multiples for the technology sector with the market as a whole, and multiples for the technology sector of Emerging Markets are established within the ranking, most fully explaining the value of stocks using an approach that ensures mitigating the differences in multiples from basic variables. © 2015, Canadian Center of Science and Education. All rights reserved.
In this paper we analyze the impact of consistency upon the accuracy of corporate values estimates provided by multiple-based valuation methods. Based on a sample with more than 6000 firm years from German firms we find consistent multiple definitions outperform in most cases inconsistent ones. The first layer consistency requirement of properly matching entity figures and equity figures increases the valuation accuracy in all cases. In a deeper analysis with respect to consistent enterprise value definitions, in the majority of cases consistent definitions still outperform inconsistent ones. We find that consistent treatment of financial leases, pensions and minority interest generally increases the valuation accuracy. However for balance sheet variable accounts payables we find mixed evidence: the inclusion results in a higher valuation accuracy for all enterprise value multiples, whereas under our hypothesis it should only do so for the EV/sales multiplier. For investments in associates and joint ventures, an inconsistent treatment also results in a higher valuation accuracy. Within the class of consistently defined multiples EBITDA multiples have the highest valuation performance followed by EBIT, net income and sales based multiples.
A sample of recommendation reports by equity analysts covering Mexican publicly traded firms in Mexico is studied. We propose a set of “most preferred” financial ratios from this sample. It is found that the most preferred ratios by equity analysts, a group of sophisticated users, are not those ratios typically covered in financial textbooks. Moreover, by using panel regression analysis, we test the relationship between financial ratios and leading stock returns during the 1995-2011 period. Overall, consistent with the efficient market hypothesis, the results show that estimates of financial ratios most preferred by equity analysts have predictive power on one-year future stock returns. We find no evidence of predictive power on two-year stock returns.
In this paper, we evaluate alternative price multiples for equity valuation purposes in the Indian context. Data are taken from 145 large companies that satisfy our screening criteria. The sample companies cover 13 prominent sectors, and the study period covers the years 1990–2007. We generate price forecasts based on each multiple by regressing the historical prices on different value drivers. We use two forecast evaluation criteria, namely root mean squared error and Theil's inequality coefficient. We find that price–to-earnings provide the best price forecast compared to the other three price multiples, price-to-book value, price to cash flow and price to sales. We also develop price forecasts based on pairwise combinations of these price multiples. The value driver combination book value-sales appears to be most efficient in terms of error minimisation. However, historical price to earnings as a standalone multiple performs better in equity valuation vis à vis all combinations of value drivers. We recommend that historical price to earnings (P/E) is the best price multiple for developing price forecasts in the Indian environment. Our findings are pertinent for market participants and financial regulators. The present work contributes to emerging market literature on equity valuation.
We evaluated various multiples practitioners use to estimate company value. We found, first, that the asset multiple (market value to book value of assets) generally generates more precise and less biased estimates than do the sales and the earnings multiples. Second, although adjusting for companies' cash levels does not improve estimates of company value, using forecasted earnings rather than trailing earnings does. Third, the earnings before interest, taxes, depreciation, and amortization (EBITDA) multiple generally yields better estimates than does the EBIT multiple. Finally, the accuracy and bias of value estimates, as well as the relative performance of the multiples, vary greatly by company size, company profitability, and the extent of intangible value in the company.
Both macro- and micro-oriented researchers frequently use panel data where the outcome of interest is measured repeated times. Panel data support at least five different modeling frameworks (within, between, incremental/emergent, cross-level, and growth). Researchers from macro- and micro-oriented domains tend to differentially use the frameworks and also use different analytic tools and terminology when using the same modeling framework. These differences have the potential to inhibit cross-discipline communication. In this review, we explore how macro- and microresearchers approach panel data with a specific emphasis on the theoretical implications of choosing one framework versus another. We illustrate how fixed-effects and random-effects models differ and how they are similar, and we conduct a thorough review of 142 articles that used panel data in leading management journals in 2017. Ultimately, our review identifies ways that researchers can better employ fixed- and random-effects models, model time as a meaningful predictor or ensure unobserved time heterogeneity is controlled, and align hypotheses to analytic choice. In the end, our goal is to help facilitate communication and theory development between macro- and micro-oriented management researchers.
Book value of equity consists of two economically different components: retained earnings and contributed capital. We predict that book-to-market strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Retained earnings-to-market predicts the cross section of average returns in U.S. and international data and subsumes book-to-market. Contributed capital-to-market has no predictive power. We show that retained earnings-to-market, and, by extension, book-to-market, predicts returns because it is a good proxy for underlying earnings yield (Ball, 1978; Berk, 1995) and not because book value represents intrinsic value.
We collect a unique dataset of Twitter posts to examine the change in investor disagreement around earnings announcements. We find that investors' opinions can either converge (reduced disagreement) or diverge (increased disagreement) around earnings announcements. The convergence and divergence of opinion has significant effects on trading volume and return. Consistent with theoretical predictions, both the convergence and divergence of opinion are associated with a greater volume reaction to earnings news. While the convergence of opinion is associated with lower earnings announcement returns, the divergence of opinion is associated with higher earnings announcement returns.
A new approach to allocate environmental responsibility, the ‘value added-based responsibility’ allocation, is presented in this article. This metric allocates total environmental pressures occurring along an international supply chain to the participating sectors and countries according to the share of value added they generate within that specific supply chain. We show that – due to their position in global value chains – certain sectors (e.g. services) and countries (e.g. Germany) receive significantly greater responsibility compared to other allocation approaches. This adds a new perspective to the discussions concerning a fair distribution of mitigation costs among nations, companies and consumers.
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.
The prime focus of the study is to empirically examine the factors affecting the capital structure decisions of small and medium enterprises (SMEs) in India. The sample consists of 174 non-financial firms. Generalised method of moments (GMM) has been applied to find out the firm specific factors affecting financing decisions of SMEs in India. The study specifically examines the effect of firm's profitability, tangibility, size, age, growth, liquidity, non-debt tax shield, cash flow ratio, and return on equity on the leverage of the firm. It confirms the applicability of the pecking order theory for SMEs in India.
We find that financial statement comparability enhances the ability of current period returns to reflect future earnings, as measured by the future earnings response coefficient (FERC). This suggests that comparability improves the informativeness of stock prices and allows investors to better anticipate future firm performance. In addition, using both the FERC and stock price synchronicity tests, we find that comparability increases the amount of firm‐specific information (rather than market/industry‐level information) reflected in stock prices. Analysts play an important role in improving stock price informativeness by producing more firm‐specific information when comparability is high. These findings suggest that comparability lowers the costs of gathering and processing firm‐specific information.
In this article, we analyze and compare several well-known methods of company valuation. In particular, we focus on the income approach (discounted cash flows, the market value added or residual income), the assets approach (net asset), and the market approach (based on value and price multiples) to value companies. This initiative aims to identify the hypothesis considered and to test the equivalence of the results obtained by these valuation methods. © 2017, Bucharest University of Economic Studies. All rights reserved.
We studied whether mean industry multiples are similar in Brazil and in the United States. Using multilevel models (hierarchical linear model and additive crossed random-effects model) we concluded that there exists significant variability within firms from the same industry and significant variability between countries (Brazil and United States). The same tests were applied to firms grouped in clusters by similarity of economic fundamentals and we concluded that part of the variability shifts from (a) the variability within firms from the same industry and the variability between countries to (b) the variability between clusters, which is desirable in multiples’ valuation.
http://www.tandfonline.com/doi/full/10.1080/1540496X.2017.1336084
This paper challenges the view that foreign investors lead firms to adopt a short-term orientation and forgo long-term investment. Using a comprehensive sample of publicly listed firms in 30 countries over the period 2001–2010, we find instead that greater foreign institutional ownership fosters long-term investment in tangible, intangible, and human capital. Foreign institutional ownership also leads to significant increases in innovation output. We identify these effects by exploiting the exogenous variation in foreign institutional ownership that follows the addition of a stock to the MSCI indexes. Our results suggest that foreign institutions exert a disciplinary role on entrenched corporate insiders worldwide.
Previous studies of analysts’ valuation methods show that sell-side analysts often rely on multiples-based relative valuation methods in deriving target price forecasts, predominantly earnings-based multiples. However, little is known about how analysts actually arrive at the earnings multiples that they apply in their valuations. Based on extant valuation theory, we analyse three benchmarks/reference points that analysts use to select these multiples using U.S. data. By mimicking analysts’ relative valuation processes, we show that analysts tend to assign earnings multiple premiums (discounts) to those firms expected to have growth premiums (higher risk levels) relative to comparable firms. We provide evidence that analysts use firms’ historical earnings multiples as benchmarks, and assign firms that are expected to have more (less) attractive fundamentals than they have had in the past earnings multiples that are at a premium (discount) relative to the average historical earnings multiples at which they traded. The forward price-earnings multiple for the broad U.S. market index signals the market’s expectations about the growth prospects of the U.S. economy and future economic conditions and we also find that changes in this multiple affect analysts’ choices of firm-specific earnings multiples.
This paper examines the explanatory power of earnings in equity valuation and value relevance of earnings through a combination of cross-section and time series regression analysis. Cross-section models are based up all US firms with a 31 December year-end in the Compustat files between 1963 and 2009. Time series models are based on a sample of 30 long-lived firms with 55 years of continuous data from 1955 through to 2009. The cross-section models show a decreasing magnitude in the elasticity of market value with respect to earnings over time relative to book value, suggesting a decline in value relevance of earnings. This finding is explained by an increasing incidence of reported losses. We find no direct evidence that the increased incidence of losses is due to poor earning quality or earnings management.
This study identifies a J-shaped relation between dividends and firm value. On average, top-dividend-payers are valued higher than all other firms, while non-dividend-payers are valued higher than low-dividend-payers. This J-shaped relation is highly stable over time as it is observed in nearly every year over the period 1962–2010, and it remains significant after controlling for firm characteristics such as profitability, growth and firm size. We also find similar J-shaped relations in stock markets outside the U.S. Our evidence suggests that dividend theories, such as the dividend catering, free-cash-flow and dividend clientele hypotheses, are inadequate to explain the J-shaped relation. It does not appear that the J-shaped pattern reflects mispricing. There is mixed evidence as to whether the J-shaped relation is driven by dividends or unobservable firm characteristics.
There is strong evidence from previous research that a discount exists for U.S. private companies relative to their publicly traded peers. Since such a PCD has substantial inf luence on the valuation of private companies, which are the main legal corporate form in Europe, we analyze, in our study, how European private companies are valued in comparison to their European publicly traded peers. We use the acquisition approach on a large sample for the 11 European countries that introduced the euro on January 1, 1999. The timespan for the selected transactions is 11 years, from 1999 to 2009. The structure of the study is based on the structure KSS used in their research on the PCD. To get the most comparable transaction pairs, we use strict selection criteria, and for valuing the PCD we choose the EBITDA multiple as the most suitable one. As a result, we find that a discount of around 5% exists for Eurozone private companies in comparison to their publicly listed peers.This is lower than the potential costs for an IPO and supports our theory that a listing gives the owner a valuable option of selling minority stakes into the stock market. However, this option does not carry the same value for every investor/owner. We also find that when using the acquisition approach, size and profitability have no significant inf luence on the PCD, which implies that every sale is unique and depends on the special situation surrounding the sale.
Valuating start-ups, especially at early stages, is a challenge given the lack of historical data and many uncertain factors about the future. This article presents a methodology for the valuation of early stage start-ups that we have proven in practice. The risk linked to a start-up is expressed through an individual beta coefficient as important component of the discounting factor within a discounted cash flow (DCF) valuation based on the data in a business plan. Core of this methodology is the development of an evaluation framework for the individual adjustment of the beta coefficient that is applicable to early stage start-ups. This was shown by applying the methodology to 16 early stage start-ups in the fields of biotechnology, nanotechnology, medical technology and clean technology, which provided an easy-to-handle and comprehensible comparison of different investment options for early stage investors.
Valuing banks, insurance companies and investment banks has always been difficult, but the market crisis of 2008 has elevated the concern to the top of the list of valuation issues. The problems with valuing financial service firm stem from two key characteristics. The first is that the cash flows to a financial service firm cannot be easily estimated, since items like capital expenditures, working capital and debt are not clearly defined. The second is that most financial service firms operate under a regulatory framework that governs how they are capitalized, where they invest and how fast they can grow. Changes in the regulatory environment can create large shifts in value. In this paper, we confront both factors. We argue that financial service firms are best valued using equity valuation models, rather than enterprise valuation models, and with actual or potential dividends, rather than free cash flow to equity. The two key numbers that drive value are the cost of equity, which will be a function of the risk that emanates from the firm's investments, and the return on equity, which is determined both by the company's business choices as well as regulatory restrictions. We also look at how relative valuation can be adapted, when used to value financial service firms.
This paper investigates the valuation performance of 16 individual value drivers, from five different value driver categories, in relation to the South African equity market for the period 2001-2010. The research results revealed, among other findings, that headline earnings is by far the most accurate value driver and that, contrary to popular belief, earnings before interest, tax, depreciation and amortisation and earnings before interest and tax are only fourth and fifth best alternatives. The evidence also suggests that, when employing multiples to perform equity valuations, a careful selection of value drivers could increase valuation accuracy by as much as 50.03%.
This study investigates the relevance of net financial expenses with respect to equity valuation in an IFRS accounting regime. According to the residual earnings valuation model, income related to balance sheet items that are recorded at fair value is not applicable for valuation purposes. There are no residual earnings associated with these items because the balance sheet provides ‘perfect’ value estimates for the items in question. In accordance with the contention that under IFRS, aggregate net financial liabilities are recorded at a book value that is close to fair value, this study demonstrates that net financial expenses are not associated with the market prices of stocks. The investigation discusses the empirical findings in light of the enduring controversies regarding the use of fair value accounting.
The FASB has asserted, without proof, that information about an enterprise's earnings based on accrual accounting generally provides a better indication of a company's ability to generate favorable cash flows than information about cash flows themselves. This study tests that assertion, empirically. The test results provide empirical evidence supporting the FASB's contention.
This study examines whether European investment analysts prefer cash flow based valuation models over accrual based models, how accurate valuation models are and whether the use of cash flow based models (with or without accrual based models) improve forecast accuracy. We conduct a comprehensive content analysis of equity research reports for most of the firms on the components list of the Dow Jones Euro Stoxx 50 Index. We find that earnings multiples and the discounted cash flow (DCF) valuation models are the two most popular valuation models and the use of accrual based multiple alongside a cash flow based model improves the forecast error and this is in line with the intuition that accruals add value relevant information to cash flows. However, we also find that neither cash flow nor earnings multiples are superior to book value and return on equity (ROE) based models in terms of forecast error. Our results provide support for the use of book value and ROE based models which provide more precise forecasts and this, in turn, supports the use of accounting based models, i.e., a residual income model.
Because of higher financial and operating risks small firms are considered to carry higher investment risks than larger ones. Plenty of empirical research found that relatively small/large companies are characterized by relatively high/low long-term average returns as well as relatively high/low variability of these returns. However, findings of different studies are far from being unequivocal as regards statistical significance, scope, stability and even direction of the relationship between firm-size and long-term risks and returns. In this paper we examine the size-effect on the Polish stock market in 1999-2011 years, using four alternative company-size measures. Our research confirmed the existence of statistically significant and strong negative relationships between long-term stock returns and company-size (with all four company-size variables statistically significant). However, our findings as regards analogous relationships between portfolios’ Betas and company-size turned out to be much more mixed.
Valuation Primer Series Issue 1 s s s s This is the first in a series of primers on fundamental valuation topics such as discounted cash flow, valuation multiples and cost of capital. s s s s This document explains how to calculate and use multiples commonly used in equity analysis. s s s s We discuss the differences between equity and enterprise multiples, show how target or 'fair' multiples can be derived from underlying value drivers and discuss the ways multiples can be used in valuation. For each multiple, we show its derivation, discuss its strengths and weaknesses, and suggest appropriate use.
Valuation Methods and shareholder value creation is a complete book about business valuation and value creation. The book explains the nuances of different valuation methods and provides the reader with the tools for analyzing and valuing any business, no matter how complex. With 631 pages divided into four parts, Valuation and shareholder value creation uses 140 diagrams, 211 tables, and more than 100 examples to help the reader absorb these concepts. This book contains materials of the MBA and executive courses that I teach in IESE Business School. It also includes some material presented in courses and congresses in Spain, US, Austria, Mexico, Argentina, Peru, Colombia, UK, Italy, France and Germany. The chapters have been modified many times as a consequence of the suggestions of my students since 1988, my work in class, and my work as a consultant specialized in valuation and acquisitions. I want to thank all my students their comments on previous manuscripts and their questions. The book also has results of the research conducted in the International Center for Financial Research at IESE. Part I - Basics of Valuation Methods and Shareholder Value Creation Part II - Shareholder Value Creation Part III - Rigorous Approaches to Discounted Cash Flow Valuation Part IV - Real options and brands
Valuation lies at the heart of much of what we do in finance, whether it is the study of market efficiency and questions about corporate governance or the comparison of different investment decision rules in capital budgeting. In this paper, we consider the theory and evidence on valuation approaches. We begin by surveying the literature on discounted cash flow valuation models, ranging from the first mentions of the dividend discount model to value stocks to the use of excess return models in more recent years. In the second part of the paper, we examine relative valuation models and, in particular, the use of multiples and comparables in valuation and evaluate whether relative valuation models yield more or less precise estimates of value than discounted cash flow models. In the final part of the paper, we set the stage for further research in valuation by noting the estimation challenges we face as companies globalize and become exposed to risk in multiple countries.
This study examines the accuracy of relative valuation methods in the U.S. insurance industry, using price as a proxy for intrinsic value. The approaches differ in terms of the fundamentals used, the adjustments made to the fundamentals, the use of conditioning variables, and the selection of comparables. The primary findings are as follows: Unlike for non-financial firms, book value multiples perform relatively well in valuing insurance companies and are not dominated by earnings multiples. In fact, over the last decade book value multiples have performed significantly better than earnings multiples. That is, estimated values calculated as the product of book value and the average price-to-book ratio of comparable insurers are generally closer to price than are similarly-calculated earnings-based value estimates; Inconsistent with the practice of many insurance analysts, excluding Accumulated Other Comprehensive Income (AOCI) from book value worsens rather than improves valuation accuracy; As expected, using income before special items instead of reported income improves valuation accuracy, but, surprisingly, excluding realized investment gains and losses does not. An exception to this latter result occurred during the financial crisis, likely due to an increase in “gains trading” activities; Conditioning the price-to-book ratio on ROE significantly improves the valuation accuracy of book value multiples. In contrast, incorporating proxies for growth, earnings quality and risk does not consistently improve out-of-sample predictions, although these determinants of the price-to-book ratio generally have the expected effects and are significant; Limiting peers to the same sub-industry (as opposed to all insurance companies) improves valuation accuracy; Adjusting with respect to potentially dilutive shares improves earnings-based valuations but not book value-based valuations; As expected, valuations based on analysts’ earnings forecasts outperform those based on reported earnings or book value. However, the gap between the valuation performance of forecasted EPS and the conditional price-to-book approach was relatively small during the last decade. Available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=1980417.