Analysts’ Estimates of the Cost of Equity Capital

64 Pages Posted: 28 Feb 2018 Last revised: 4 Apr 2019

See all articles by Karthik Balakrishnan

Karthik Balakrishnan

London Business School

Lakshmanan Shivakumar

London Business School

Peeyush Taori

London Business School

Date Written: March 3, 2019

Abstract

We explore a large sample of analysts’ estimates of cost of equity capital (CoE) revealed in analysts’ reports to evaluate their determinants and ability to capture expected stock returns. We first document that CoE estimates are more likely to be provided by less experienced and less busy analysts and for harder-to-value firms. We also find that CoE estimates are significantly related to beta, size, book-to-market ratio, leverage and idiosyncratic volatility but not to profitability, investments or other return predictors. The CoE estimates also incrementally predict future stock returns, which possibly reflects analysts’ ability to garner information about expected returns through their direct interactions with investors. We also find that analysts increase their CoE estimates following extreme earnings surprises, indicating that companies with volatile earnings as perceived as more risky. Finally, based on a pair-wise comparison of CoE estimates with alternative expected return proxies (estimated from CAPM, Fama-French factor models or implied cost of capital models), we find that CoE estimates tend to be least noisy. We conclude that analysts’ CoE estimates, where available, are a useful proxy for expected stock returns.

Keywords: Analysts, Expected Stock Returns, Discount Rates, Cost of Equity

JEL Classification: G12, G17, G24

Suggested Citation

Balakrishnan, Karthik and Shivakumar, Lakshmanan and Taori, Peeyush, Analysts’ Estimates of the Cost of Equity Capital (March 3, 2019). Available at SSRN: https://ssrn.com/abstract=3126293 or http://dx.doi.org/10.2139/ssrn.3126293

Karthik Balakrishnan (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, NW1 4SA
United Kingdom

Lakshmanan Shivakumar

London Business School ( email )

Regent's Park
London, NW1 4SA
United Kingdom
+44 20 7000 8115 (Phone)
+44 20 7000 8101 (Fax)

HOME PAGE: http://faculty.london.edu/lshivakumar/

Peeyush Taori

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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