Using Earnings Forecasts to Simultaneously Estimate Firm-Specific Cost of Equity and Long-Term Growth

64 Pages Posted: 15 Dec 2010 Last revised: 9 Mar 2011

See all articles by Alexander Nekrasov

Alexander Nekrasov

University of Illinois Chicago

Maria Ogneva

University of Southern California - Marshall School of Business

Date Written: March 3, 2011

Abstract

A growing body of literature in accounting and finance relies on implied cost of equity (COE) measures. Such measures are sensitive to assumptions about terminal earnings growth rates. In this paper we develop a new COE measure that is more accurate than existing measures because it incorporates endogenously estimated long-term growth in earnings. Our method extends Easton, Taylor, Shroff, and Sougiannis’ (2002) method of simultaneously estimating sample average COE and growth. Our method delivers COE (growth) estimates that are significantly positively associated with future realized stock returns (future realized earnings growth). Moreover, the predictive ability of our COE measure subsumes that of other commonly used COE measures and is incremental to commonly used risk characteristics. Our implied growth measure fills the void in the earnings forecasting literature by robustly predicting earnings growth beyond the five-year horizon.

Keywords: Cost of equity, expected return, expected earnings growth, residual income model

JEL Classification: G12, G14, G17, G31, M41

Suggested Citation

Nekrasov, Alexander and Ogneva, Maria, Using Earnings Forecasts to Simultaneously Estimate Firm-Specific Cost of Equity and Long-Term Growth (March 3, 2011). Review of Accounting Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1725481

Alexander Nekrasov

University of Illinois Chicago ( email )

1200 W Harrison St
Chicago, IL 60607
United States

HOME PAGE: http://business.uic.edu/profiles/alexander-nekrasov/

Maria Ogneva (Contact Author)

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

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