Download or read book Can the Implied Cost of Capital from a Mechanical Earnings Forecast Model Proxy the Expected Cost of Capital written by Ling Lei and published by . This book was released on 2000 with total page 80 pages. Available in PDF, EPUB and Kindle. Book excerpt:

Download or read book Estimating the Cost of Capital Implied by Market Prices and Accounting Data written by Peter Easton and published by Now Publishers Inc. This book was released on 2009 with total page 148 pages. Available in PDF, EPUB and Kindle. Book excerpt: Estimating the Cost of Capital Implied by Market Prices and Accounting Data focuses on estimating the expected rate of return implied by market prices, summary accounting numbers, and forecasts of earnings and dividends. Estimates of the expected rate of return, often used as proxies for the cost of capital, are obtained by inverting accounting-based valuation models. The author describes accounting-based valuation models and discusses how these models have been used, and how they may be used, to obtain estimates of the cost of capital. The practical appeal of accounting-based valuation models is that they focus on the two variables that are commonly at the heart of valuations carried out by equity analysts -- forecasts of earnings and forecasts of earnings growth. The question at the core of this monograph is -- How can these forecasts be used to obtain an estimate of the cost of capital? The author examines the empirical validity of the estimates based on these forecasts and explores ways to improve these estimates. In addition, this monograph details a method for isolating the effect of any factor of interest (such as cross-listing, fraud, disclosure quality, taxes, analyst following, accounting standards, etc.) on the cost of capital. If you are interested in understanding the academic literature on accounting-based estimates of expected rate of return this monograph is for you. Estimating the Cost of Capital Implied by Market Prices and Accounting Data provides a foundation for a deeper comprehension of this literature and will give a jump start to those who have an interest in these topics. The key ideas are introduced via examples based on actual forecasts, accounting information, and market prices for listed firms, and the numerical examples are based on sound algebraic relations.

Download or read book Properties of Implied Cost of Capital Using Analysts Forecasts written by Wayne R. Guay and published by . This book was released on 2012 with total page 26 pages. Available in PDF, EPUB and Kindle. Book excerpt: We evaluate the influence of measurement error in analysts' forecasts on the accuracy of implied cost of capital estimates from various implementations of the 'implied cost of capital' approach, and develop corrections for the measurement error. The implied cost of capital approach relies on analysts' short- and long-term earnings forecasts as proxies for the market's expectation of future earnings, and solves for the implied discount rate that equates the present value of the expected future payoffs to the current stock price. We document predictable error in the implied cost of capital estimates resulting from analysts' forecasts that are sluggish with respect to information in past stock returns. We propose two methods to mitigate the influence of sluggish forecasts on the implied cost of capital estimates. These methods substantially improve the ability of the implied cost of capital estimates to explain cross-sectional variation in future stock returns, which is consistent with the corrections being effective in mitigating the error in the estimates due to analysts' sluggishness.

Download or read book The Implied Cost of Capital written by Carl Barkfeldt and published by . This book was released on 2022 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: This study examines whether improvements in earnings forecasting translate into improvements in implied cost of capital estimates of expected returns. I attain high-performing earnings forecasting via a machine learning approach. In particular, I implement and evaluate six popular machine learning methods to forecast earnings based on a comprehensive set of predictor variables. The evaluation demonstrates that the non-linear machine learning methods - Gradient Boosted Regression Trees and Artificial Neural Network - can generate earnings forecasts for up to five years ahead that exhibit less bias and better accuracy than state-of-the-art panel-regression benchmarks as well as a random walk forecast. Moreover, I estimate the implied cost of capital on a sample of U.S. stocks spanning 2000-2017. The general result indicates that improvements in earnings forecasting do not translate into improvements in return predictability. While issues with the implied cost of capital methodology could explain the results, another possible explanation is market mispricing.

Download or read book Evaluating Cross Sectional Forecasting Models for Implied Cost of Capital written by Kevin K. Li and published by . This book was released on 2014 with total page 47 pages. Available in PDF, EPUB and Kindle. Book excerpt: The computation of implied cost of capital (ICC) is constrained by the lack of analyst forecasts for half of all firms. Hou, van Dijk, and Zhang (2012, HVZ) present a cross-sectional model to generate forecasts in order to compute ICC. However, the forecasts from the HVZ model perform worse than those from a naïve random walk model and the ICCs show anomalous correlations with risk factors. We present two parsimonious alternatives to the HVZ model: the EP model based on persistence in earnings and the RI model based on the residual income model from Feltham and Ohlson (1996). Both models outperform the HVZ model in terms of forecast bias, accuracy, earnings response coefficients, and correlations of the ICCs with future returns and risk factors. We recommend that future research use the RI model or the EP model to generate earnings forecasts.

Download or read book Implied Cost of Capital in the Cross Section of Stocks written by Namho Kang and published by . This book was released on 2017 with total page 39 pages. Available in PDF, EPUB and Kindle. Book excerpt: Recent research shows that the implied cost of capital (ICC), measured from analyst forecasts and current stock prices, positively predicts returns at the aggregate level. In contrast, there is a strong negative relation between ICC and future returns in the cross-section. We hypothesize that mispricing due to optimistic analyst forecasts and earnings uncertainty renders ICC a poor proxy for expected returns, leading to the negative cross-sectional relation. Consistent with this hypothesis, we find that (1) high-ICC firms tend to have more optimistic analyst forecasts; (2) the underperformance of high-ICC firms is pronounced for firms with a high predictable analyst bias; and (3) mispricing due to earnings uncertainty further strengthens the negative relation between ICC and future returns. The findings suggest that not only bias in analyst forecasts but also mispricing may significantly affect the estimation of ICC at the firm level.

Download or read book Toward an Implied Cost of Capital written by William R. Gebhardt and published by . This book was released on 2001 with total page 78 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this study, we propose an alternative technique for estimating the cost of equity capital. Specifically, we use a discounted residual income model to generate a market implied cost-of-capital. We then examine firm characteristics that are systematically related to this estimate of cost-of-capital. We show that a firm's implied cost-of-capital is a function of its industry membership, B/M ratio, forecasted long-term growth rate, and the dispersion in analyst earnings forecasts. Together, these variables explain around 60% of the cross-sectional variation in future (two-year-ahead) implied costs-of-capital. The stability of these long-term relations suggests they can be exploited to estimate future costs-of-capital. We discuss the implications of these findings for capital budgeting, investment decisions, and valuation research.

Download or read book The Impact of Analyst Investor Disagreement on the Cross Section of Implied Cost of Capital written by Michalis Makrominas and published by . This book was released on 2015 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: Implied cost of capital estimates are typically calculated using analysts' forecasts as proxies for the market's earnings expectations. We examine the case where deviations between investors' expectations and analysts' beliefs, as manifested by analysts' recommendations, cause predictable variation in implied cost of capital. We find that stocks recommended by analysts as Buy or Strong Buy have, ceteris paribus, higher implied cost of capital than stocks recommended as Underperform or Sell, and that the effect is more clearly pronounced in stocks that have been downgraded. We attribute the effect to differential expectations between analysts and investors regarding future profitability, rather than differential expectations regarding systematic risk. We demonstrate that adjusting analysts' earnings forecasts in line with the market's earnings expectations largely eliminates the observed variation, indicating that such corrective mechanisms could and should be incorporated in the estimation of implied cost of capital.

Download or read book Estimating the Intertemporal Risk return Tradeoff Using the Implied Cost of Capital written by Luboš Pástor and published by . This book was released on 2006 with total page 72 pages. Available in PDF, EPUB and Kindle. Book excerpt: We reexamine the time-series relation between the conditional mean and variance of stock market returns. To proxy for the conditional mean return, we use the implied cost of capital, computed using analyst forecasts. The usefulness of this proxy is shown in simulations. In empirical analysis, we construct the time series of the implied cost of capital for the G-7 countries. We find strong support for a positive intertemporal mean-variance relation at both the country level and the world market level. Some of our evidence is consistent with international integration of the G-7 financial markets.

Download or read book Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns written by Stephannie Larocque and published by . This book was released on 2017 with total page 50 pages. Available in PDF, EPUB and Kindle. Book excerpt: Using a popular return decomposition, we show that expected returns should on average be positively associated with future return on equity (ROE), controlling for the book-to-market ratio (BM). However, we find that none of the commonly-used implied cost of equity capital estimates (ICCs), which proxy for expected returns, are positively associated with future ROE. This lack of association with future accounting returns appears to affect the ability of ICCs to forecast future stock returns: ICCs do not provide information about future stock returns incremental to that contained in a linear combination of current ROE and BM. Our findings suggest that tractable accounting-based models that linearly combine BM and ROE, or other accounting-based variables, offer improvements on extant ICCs as expected returns proxies.

Download or read book Market Inefficiency and Implied Cost of Capital Models written by Tjomme O. Rusticus and published by . This book was released on 2019 with total page 79 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper, I examine the impact of market inefficiency on the properties of implied cost of capital (ICC) estimates. I show that market inefficiency will bias the relation between the ICC estimate and future returns upwards. Utilizing recently developed ICC estimates formed using regression based earnings forecasts, I show that a substantial portion of the returns to an ICC trading strategy stem from mispricing rather than expected returns. The biases induced by mispricing are most severe for firms with significant limits to arbitrage and less severe for firms that are larger, more liquid, and have lower transaction costs, and for ICC estimates based on adjusted analyst forecasts. In addition, I find that controlling for earnings and discount rate news is not an effective control for mispricing, but that controlling for earnings announcement returns is at least partially effective.

Download or read book Implied Cost of Capital Versus Fundamental Valuation Efficiency written by C.S. Agnes Cheng and published by . This book was released on 2019 with total page 122 pages. Available in PDF, EPUB and Kindle. Book excerpt: As the proxy for expected return, the implied cost of capital (ICC) is subject to a mispricing-driven measurement error because the price of a stock used to compute ICC can deviate from its intrinsic value. For undervalued stocks, the mispricing-driven measurement error is positive and increases with the degree of undervaluation while for overvalued stocks, the mispricing-driven measurement error is negative and decreases with the degree of overvaluation. Therefore, ceteris paribus, lower ICC is equivalent to higher (lower) fundamental valuation efficiency (FVE) for undervalued (overvalued) stocks. Furthermore, our evidence, based on 11 constructs, shows that the estimated relation of an FVE-associated construct with ICC is a potentially biased estimate of its relation with expected return because its estimated relation with ICC also captures its relation with the mispricing-driven measurement error, the sign of which switches between undervalued and overvalued stocks. Existing methods do not seem able to address the bias.

Download or read book The Performance of Mechanical Earnings Forecasts written by Dieter Hess and published by . This book was released on 2019 with total page 46 pages. Available in PDF, EPUB and Kindle. Book excerpt: We analyze three different mechanical models to forecast earnings and compare their forecasts with those of analysts. Moreover, we evaluate implied cost of capital (ICC) estimates that are based on these forecasts. With our analyses we answer three open questions in the literature. 1) Do model forecasts or analysts' forecasts perform better? 2) Are ICCs derived from analysts' forecasts more reliable than ICCs based on model forecasts? And 3) does higher forecast performance also translate into more reliable ICCs? First, we find that analysts' forecasts are even more accurate than the most accurate model forecasts. However, second, we find that model-based ICCs are always more reliable than analyst-based ICCs. Moreover, model-based ICCs are particularly reliable for a sample of firms for which no analysts' forecasts are available. While the lack of reliability of analyst-based ICCs seems to indicate a missing link between forecast performance and ICC reliability, in fact, third, we find that ceteris paribus higher forecast performance translates into more reliable ICCs, that is, within one earnings definition the most accurate forecasts also yield the most reliable ICCs.

Download or read book Commentary on Implied Cost of Equity Capital Estimates as Predictors of Accounting Returns and Stock Returns written by Charles C. Y. Wang and published by . This book was released on 2017 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: The expected rate of equity returns is a central input into various managerial and investment decisions that affect the allocation of scarce resources. Research on capital markets has devoted significant effort to studying how and why expected returns vary over time and across firms. Cochrane (2011) called these questions the central organizing agenda in contemporary asset-pricing research.At the heart of this research agenda lies a longstanding measurement problem: ex-ante expected returns are unobservable and ex-post realized returns are noisy proxies (Campbell, 1991; Vuolteenaho, 2002). Since Botosan (1997), the accounting literature offered a promising solution to this measurement problem: the development of a novel class of expected-return proxies (ERPs), collectively known as the implied cost of equity capital (ICC).

Download or read book Expected Earnings Growth and the Cost of Capital written by Christina Dargenidou and published by . This book was released on 2006 with total page 33 pages. Available in PDF, EPUB and Kindle. Book excerpt: This study focuses on the relation between the cost of equity capital and earnings expectations when the properties of accounting that determine earnings vary across different regulatory regimes. More particularly, it addresses the European setting where different types of GAAP regime have continued to function in the presence of the gradual harmonization of the underlying legal framework, and where the adoption of internationally recognised accounting standards by certain firms has anticipated the requirement for International Financial Reporting Standards. On the basis of estimates of the cost of equity that are implied by analysts' earnings forecasts, the paper provides evidence that financial market integration may have already contributed to mitigating the economic consequences of accounting diversity, and that switching to IFRS could have a short lived impact on capital markets. Moreover, based on firm level transparency and disclosure rankings provided by Standard and Poor's, it is shown how the quality of financial reporting conditions the implied cost of equity under different GAAP.

Download or read book Use of Forecasts of Earnings to Estimate and Compare Cost of Capital Across Regimes written by Peter D. Easton and published by . This book was released on 2006 with total page 35 pages. Available in PDF, EPUB and Kindle. Book excerpt: I critically examine several of the methods used in the recent literature to estimate and compare the cost of capital across different accounting/regulatory regimes. I focus on the central importance of expectations of growth beyond the short period for which forecasts of future pay-offs (dividends and/or earnings) are available. I illustrate, using the stocks that comprised the Dow Jones Industrial Average (DJIA) at December 31, 2004 as an example, the differences between the growth rates implied by the data, and growth rates that are often assumed in the literature. My analyses show that assumptions about growth beyond the (short) forecast horizon may seriously affect the estimates of the expected rate of return and may lead to spurious inferences.

Download or read book Accounting Based Estimates of the Cost of Capital written by Stephen H. Penman and published by . This book was released on 2016 with total page 69 pages. Available in PDF, EPUB and Kindle. Book excerpt: This paper offers an approach for estimating the cost of capital from observed accounting information and compares the resulting estimates to so-called implied cost of capital (ICC) calculations and those from asset pricing models. The approach is based on two ideas. First, buying expected earnings growth is risky; thus, any variable that predicts expected earnings growth that is at risk of not being realized is potentially an indicator of the cost of capital. Second, accounting principles induce earnings growth that ties to risk; thus, an accounting number generated under these principles potentially indicates of the cost of capital. The paper combines such numbers into a cost-of-capital estimate. The estimates perform well in validation tests, in contrast to the alternatives that are the current standards.