Earnings Growth Uncertainty and the Cross-section of Equity Valuation

Abstract

We provide direct empirical evidence that higher growth uncertainty is associated with lower equity valuation. To do so, we develop an equity valuation model where the investor learns about the unobservable expected earnings growth. Expected earnings growth can be more difficult to assess for some firms than others, depending on the available information. This implies cross-sectional differences in growth uncertainty. We provide a theoretically founded measure of growth uncertainty, which we structurally estimate at the firm level. This measure is then shown to drive cross-sectional variations of the market-to-book ratio, both theoretically and empirically, thereby contributing to our understanding of equity valuation ratios.

Keywords: Equity valuation, uncertainty, learning, analyst forecasts