Valuation uncertainty and analysts’ use of DCF models

Using textual analysis for a large sample of analyst reports on U.S. firms, we find that analysts are more likely to use a discounted cash flow (DCF) model and to discuss more cash flow and discount rate information for firms with more uncertainty, as measured by earnings quality and firm risks. The market reactions to target price changes based on a DCF model are stronger, particularly for firms with greater valuation uncertainty and when the analysts present more cash flow and discount rate discussions. These results indicate that the analyst valuation process reflects investors’ information demand under uncertainty and has a bearing on the informativeness of analyst research.