Valuation Fundamentals

Abstract

We study subjective valuation using a comprehensive sample of 78,000 analyst reports that contain detailed information on subjective discount rates and the entire term structure of cash flow growth expectations. We find that both growth expectations and subjective discount rates play an important role in explaining valuation fluctuations; and that the risk-free rate and subjective betas are the primary drivers of discount rate fluctuations over time. Analysts' subjective discount rates are unbiased predictors of future returns, and the relation of betas to future returns is closely related to risk premia, resulting in a steep subjective security market line. To rationalize these findings, we show that analysts update key subjective inputs in a manner consistent with filtering estimation noise via Bayesian updating under imperfect information. Finally, analyst terminal growth rates track real GDP growth, but not inflation.

Keywords: G41 valuation, horizon, expectations, discount rates, behavioral finance, beliefs updating, analyst, stock market returns

JEL Classification: D24, D25, D46, D84, G17, G31, G41