The Use of Residual Income Valuation Methods by U.S. Sell-Side Equity Analysts
Abstract
We study the use of residual income (RI) valuation methods by U.S. sell-side equity analysts, particularly as compared to DCF. We document that RI valuations are rare — just 1/16th as common as DCF — and that different RI and DCF valuations are not infrequently provided by the same analyst for the same firm in the same report. We find that while analysts build their RI models around both net operating income (RNOA-RI) and net income (ROE-RI), analysts’ RNOA-RI valuations are as optimistic as their DCF valuations and contain RNOAs that increase to an economically implausible terminal year median of 27%. In contrast, analysts’ ROE-RI valuations contain ROEs that decline over the forecast horizon to a more plausible terminal year median of 17%. While optimistic when done on their own, analysts’ ROE-RI valuations are unbiased when done in tandem with DCF, as are the DCFs that accompany them.
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- Keyword(s):
- accounting 109
- equity markets 41
https://kenaninstitute.unc.edu/publication/the-use-of-residual-income-valuation-methods-by-u-s-sell-side-equity-analysts/
