Rights statement: 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
Accepted author manuscript, 446 KB, PDF document
Available under license: CC BY-NC: Creative Commons Attribution-NonCommercial 4.0 International License
Final published version
Research output: Contribution to Journal/Magazine › Journal article › peer-review
Research output: Contribution to Journal/Magazine › Journal article › peer-review
}
TY - JOUR
T1 - How do sell-side analysts obtain price-earnings multiples to value firms?
AU - Yin, Yuan
AU - Peasnell, Kenneth Vincent
AU - Hunt, Herbert G.
N1 - 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
PY - 2018/1
Y1 - 2018/1
N2 - 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.
AB - 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.
KW - Relative valuation
KW - analyst target P/E multiple
KW - P/E multiple premium
KW - growth and risk premiums
KW - deviation from long-run average
U2 - 10.1080/00014788.2016.1230486
DO - 10.1080/00014788.2016.1230486
M3 - Journal article
VL - 48
SP - 108
EP - 135
JO - Accounting and Business Research
JF - Accounting and Business Research
SN - 0001-4788
IS - 1
ER -