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How do sell-side analysts obtain price-earnings multiples to value firms?

Research output: Contribution to journalJournal article

<mark>Journal publication date</mark>01/2018
<mark>Journal</mark>Accounting and Business Research
Issue number1
Number of pages28
Pages (from-to)108-135
Early online date16/11/16
<mark>Original language</mark>English


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 P/E 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.

Bibliographic note

This is an Accepted Manuscript of an article published by Taylor & Francis in Accounting and Business Research on 16/11/2016, available online: http://www.tandfonline.com/10.1080/00014788.2016.1230486