Equity Valuation Based on Management Earnings Forecasts: An Evaluation of Gao et al. (2019)

Abstract

This study addresses whether the hybrid equity valuation model proposed by Gao et al. (2019) is applicable for evaluating Japanese firms, using management earnings forecasts. Three aspects on the quality of value estimates are examined: the degree to which the estimated equity value approximates the actual stock price; the bias, which is the difference between the actual and estimated equity value; the absolute valuation error measured by the absolute value of the bias; the coefficient of determination from regressing stock prices on estimated equity values. In addition, this study estimates the implied cost of capital by solving each valuation model in terms of discount rate and investigates how this implied cost of capital is correlated with various risk indicators. The results of this study demonstrate that the quality of equity valuation can be improved, specifically in terms of risk assessment, by introducing management earnings forecasts as an input to the hybrid model.