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Relative accuracy and predictive ability of direct valuation methods, price to aggregate earnings method and a hybrid approach

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  • Lucie Courteau
  • Jennifer L. Kao
  • Terry O’Keefe
  • Gordon D. Richardson

Abstract

In this paper, we assess the relative performance of the direct valuation method and industry multiplier models using 41 435 firm‐quarter Value Line observations over an 11 year (1990–2000) period. Results from both pricing‐error and return‐prediction analyses indicate that direct valuation yields lower percentage pricing errors and greater return prediction ability than the forward price to aggregated forecasted earnings multiplier model. However, a simple hybrid combination of these two methods leads to more accurate intrinsic value estimates, compared to either method used in isolation. It would appear that fundamental analysis could benefit from using one approach as a check on the other.

Suggested Citation

  • Lucie Courteau & Jennifer L. Kao & Terry O’Keefe & Gordon D. Richardson, 2006. "Relative accuracy and predictive ability of direct valuation methods, price to aggregate earnings method and a hybrid approach," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 46(4), pages 553-575, December.
    • Handle: RePEc:bla:acctfi:v:46:y:2006:i:4:p:553-575
    DOI: 10.1111/j.1467-629X.2006.00183.x
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    References listed on IDEAS

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    1. Lucie Courteau & Jennifer L. Kao & Gordon D. Richardson, 2001. "Equity Valuation Employing the Ideal versus Ad Hoc Terminal Value Expressions," Contemporary Accounting Research, John Wiley & Sons, vol. 18(4), pages 625-661, December.
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    4. Sanjeev Bhojraj & Charles M. C. Lee, 2002. "Who Is My Peer? A Valuation‐Based Approach to the Selection of Comparable Firms," Journal of Accounting Research, Wiley Blackwell, vol. 40(2), pages 407-439, May.
    5. Brian J. Bushee, 2001. "Do Institutional Investors Prefer Near†Term Earnings over Long†Run Value?," Contemporary Accounting Research, John Wiley & Sons, vol. 18(2), pages 207-246, June.
    6. Alford, Aw, 1992. "The Effect Of The Set Of Comparable Firms On The Accuracy Of The Price Earnings Valuation Method," Journal of Accounting Research, Wiley Blackwell, vol. 30(1), pages 94-108.
    7. Dechow, Patricia M. & Hutton, Amy P. & Sloan, Richard G., 1999. "An empirical assessment of the residual income valuation model1," Journal of Accounting and Economics, Elsevier, vol. 26(1-3), pages 1-34, January.
    8. Fama, Eugene F. & French, Kenneth R., 1997. "Industry costs of equity," Journal of Financial Economics, Elsevier, vol. 43(2), pages 153-193, February.
    9. Bandyopadhyay, Sati P. & Brown, Lawrence D. & Richardson, Gordon D., 1995. "Analysts' use of earnings forecasts in predicting stock returns: Forecast horizon effects," International Journal of Forecasting, Elsevier, vol. 11(3), pages 429-445, September.
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    1. Bixia Xu & Michel L. Magnan & Paul E. André, 2007. "The Stock Market Valuation of R&D Information in Biotech Firms," Contemporary Accounting Research, John Wiley & Sons, vol. 24(4), pages 1291-1318, December.

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