Peering Inside the Analyst 'Black Box': How Do Equity Analysts Model Companies?
46 Pages Posted: 20 Mar 2014 Last revised: 30 Mar 2014
Date Written: March 20, 2014
We examine a set of equity analysts' private models from a large investment bank equity research department as a new way of understanding how analysts actually value the companies their follow. We identify their valuation approaches and use of inputs, including equity research premium, risk free rate and beta. We find that the analysts broadly follow textbook valuation approaches in their discounted cash flow analysis, including at least five years of explicit forecasts, a perpetuity-based terminal value and reasonable long term growth rate assumptions. But they are not always consistent in their use of valuation parameters. We hypothesise that analysts can manipulate their inputs to achieve desired valuation outputs while maintaining the appearance of theoretically sound valuation methods.
Keywords: Valuation, analysts forecasts, capital markets
JEL Classification: G24, M41, G15
Suggested Citation: Suggested Citation