Valuation Methods Used by Financial Analysts and Target Price Accuracy

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Abstract

This study analyses the full text of financial analyst reports and attempts to understand whether the choice of a specific valuation method used by analysts affects target price accuracy. Our analysis of the different types of valuation methods shows that they lead to the same level of accuracy. This indicates that the development of a complex and time-consuming company fundamental analysis in the hope of achieving better company evaluation is not valuable. The market and fundamental approaches do not differ significantly in accuracy levels, except for the net asset method, which results in lower accuracy. Our empirical evidence also shows that target prices supported by the disclosure of the valuation methods used are as accurate as those issued without contemporaneous disclosure. Moreover, the accuracy of the target price decreases when the target price is based on one main method. We argue that this result suggests that analysts evaluating companies can obtain more accurate performances by simply combining a few wisely chosen techniques, instead of using only one method. Lastly, when considering primary methods only, there are no significant differences in the accuracy associated with methods based on company fundamentals versus those based on market multiples.
Overall, this research indicates that target price accuracy does not depend on the choice of specific valuation method, but on the valuation procedure adopted by the analysts. In other words, our empirical evidence suggests that in order to improve the accuracy of their forecasts, analysts need to assess company value by choosing and applying a set of different methods, combining them and obtaining an average value, regardless of the specific technique chosen. Therefore, as we find no differences in the performance ability of the methods, we do not confirm the finance textbooks’ theory of a hierarchy amongst methods, promoting the multi-period valuation models as superior.

Authors

• Elisa Cavezzali, Ca' Foscari University of Venice

• Ugo Rigoni, Ca' Foscari University of Venice

• Siva Nathan, Georgia State University