Return On Equity Estimates And Fourquadrant Square Position: Evidence From Taiwan

This study examines the extent to which security analysts’ forecasts help improve our classifying the observations into the Damodaran’s four-quadrant square box. Based on the square box, we show that companies classified into quadrant (I) by Historical Return on Equity (HROE) will move to quadrant (II) in the subsequent period. We find security analysts perform better than HROE in predicting the fourquadrant box outcome in the subsequent period. Our empirical result shows the Consensus Return on Equity (CROE) performs better than HROE in predicting the four-quadrant box in the subsequent period. Due to the fact that a firm’s accounting earnings may deviate from its economic earnings, analysts may strategically pursue forecast accuracy, especially in the short term, at the expense of information users in the long term. Specifically, analysts’ longer-horizon earnings forecasts may be more informative than current- and subsequent-year EPS forecasts as to the true value of a firm’s long-term investment projects. Accordingly, analysts’ longer-termed earnings forecasts outperform their current- and subsequent-year EPS forecasts in predicting the four-quadrant box in the subsequent period.