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E-RESOURCE
Author Easton, Peter.

Title Estimating the cost of capital implied by market prices and accounting data [electronic resource] / Peter Easton.

Published Hanover, Mass. : Now Publishers, c2009.

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 UniM INTERNET resource    AVAILABLE
 UniM INTERNET resource    AVAILABLE
Physical description 1 electronic text (p. 241-364) : PDF digital file.
Series Foundations and trends in accounting, 1554-0650 ; v. 2, issue 4, p. 241-364
Foundations and trends in accounting (Online), 1554-0650 ; v. 2, issue 4, p. 241-364.
Notes Title from PDF t.p. (viewed on April 5, 2009).
Bibliography Includes bibliographical references (p. 359-364).
Contents Abstract -- Introduction -- Valuing the firm -- The discounted cash flow valuation model -- A simple example -- The residual operating income valuation model -- Reverse engineering -- The algebra of the derivation of the accounting-based valuation models -- The derivation of the residual operating income valuation model -- Summary -- Changing the focus to the valuation of equity and introducing reverse engineering -- The dividend capitalization model -- A simple example -- The residual income valuation model -- Reverse engineering the residual income valuation model -- The importance of simultaneously estimating both the implied expected rate of return and the implied expected growth rate -- Formal derivation of the residual income valuation model -- The importance of the clean-surplus assumption -- Summary -- Reverse engineering the abnormal growth in earnings valuation model: PE ratios and PEG ratios -- The abnormal growth in earnings valuation model -- Formal derivation of the abnormal growth in earnings valuation model -- The connection between the abnormal growth in earnings valuation model and the residual income valuation model -- A simple example -- What is abnormal growth in earnings -- The concept of economic earnings -- What is growth in abnormal growth in earnings -- Special case: PE ratios -- PE ratios and PEG ratios -- Stock recommendations based on the PEG ratio -- The modified PEG ratio -- The PEG ratio -- The GODE and Mohanram modification -- Conclusion regarding modifications -- Summary -- Reverse engineering the residual income valuation model to obtain firm-specific estimates of the implied expected rate of return -- Reverse engineering the residual income valuation model -- Approaches to the problem of growth rates beyond the forecast horizon -- Advantages/disadvantages -- Gebhardt et al (2001) -- Why fade to the industry median return-on-equity -- What is the appropriate industry comparison group -- Claus and Thomas (2001) -- Growth at rf -3% -- Growth stemming from accounting conservatism is not zero -- Firm-specific estimates are unlikely to be meaningful when the same growth rate is applied to all firms -- A model that fades to the cost of capital -- Summary -- Reverse engineering the abnormal growth in earnings valuation model to obtain portfolio-level estimates of the implied expected rate of return -- A method for simultaneously estimating the rate of change in abnormal growth in earnings and the expected rate of return -- A word of caution -- Bias in estimates of the expected rate of return based on the peg ratio -- An illustration: P&G -- The regression-based estimate for P&G -- An illustration: large sample evidence of the effect of assumptions about long-term growth in earnings -- The importance of high r-square in the Easton (2004) regression -- An example: the DJIA as of December 31, 2004 -- Summary -- Reverse engineering the residual income valuation model to obtain portfolio-level estimates of the implied expected rate of return -- Simultaneously estimating the rate of growth in residual income and the expected rate of return that are implied by market prices, book value, and forecasts of earnings -- Earnings aggregation -- Example of earnings aggregation: P&G -- The ETSS iterative procedure -- An illustration: large sample evidence of the effect of assumptions about long-term growth in residual income -- The trade-off between using just one quarter or just one year of earnings and using all available forecast data -- Simultaneously estimating the rate of growth in residual income and the expected rate of return that are implied by market prices, book value, and current earnings -- A key issue is the implicit assumption that the accounting data summarize the payoffs about which the investor is concerned when determining the value of the stock -- Which earnings -- A need for caution -- Value-weighted estimates of the implied expected rate of return -- Summary -- Methods for assessing the quality/validity of firm-specific estimates -- The motivation for estimating accounting-based estimates of the expected rate of return at the firm level -- Do the estimates of ex ante expected return explain ex post realized return -- Correlated omitted variables bias -- Using realized return as a measure of validity is at odds with the motivation for using accounting-based estimates -- The components of realized returns -- A method for evaluating estimates of expected returns -- All components of realized returns are measured with error -- Correlations with realized return as the method for evaluating expected return proxies -- Evaluation based on the regression of the estimates of the expected rate of return on commonly used risk proxies -- The regression of the firm-specific estimate of the return premium on risk proxies -- Shortcomings of the regression approach -- Illustration of spurious effects -- The role of correlations with risk proxies -- The importance of focusing on measurement error -- Summary -- Extant firm-specific estimates are poor -- Comparison with the risk-free rate and other descriptive statistics -- Correlation with realized returns -- The measurement error variance of the estimates of the expected rate of return -- Ranking of the methods for estimating the expected rate of return -- Summary -- Bias in estimates of the expected rate of return due to bias in earnings forecasts -- Bias matters -- An ex ante measure of optimism -- Bias is the difference between estimates based on forecasts of earnings and estimates based on earnings realizations -- Ex ante and ex post measures of bias -- Ex ante determination of the effect of bias -- Ex post determination of the effect of bias -- Ex ante and ex post comparison -- Empirical estimate of the ex ante bias -- Empirical estimate of ex post bias -- Which earnings are related to prices? does the market see through the forecast bias -- Summary -- Dealing with shortcomings in firm-specific estimates -- Methods for mitigating the effects of measurement error -- Grouping -- Variables that may be used to form groups -- Empirical evidence of the effects of grouping -- Instrumental variables -- Variables that may be used as instruments -- Empirical evidence of the effectiveness of instrumental variables -- The errors in variables problem may be less severe for some subsets of the data -- The relevance of the vast literature on analysts' forecast errors -- Sub-samples where the error and/or bias may be less -- Reducing the error and/or reducing the effects of the error: an example -- Methods for dealing with, so-called, "sluggish" forecasts -- Critique of methods -- Reducing the forecast error by the predicted value from a regression of forecast errors on various firm characteristics -- Combining time-series forecasts and analysts' forecasts -- Summary -- Methods for determining the effect of a phenomenon of interest on the cost of capital -- Examples of phenomena studied in the extant literature -- The most common methodology -- A method for comparing expected rates of return across groups of stocks -- Controlling for effects other than the effect of interest -- Introducing controls in the dummy variable regression -- Additional dummy variables or interaction terms -- Matched-sample design -- The firm as its own control -- Matching and the firm as its own control: the dummy variable regression -- Expected growth rates are determined by the data -- Summary -- Data issues.
Misalignment of prices, book values, and earnings forecasts -- An example: P&G -- A close look at the time-line for these forecasts -- The earnings forecast may be for a fiscal period that has ended -- Book value will not be known until the earnings announcement date -- Forecasted book value as the anchor -- One option: calculate implied expected rates of return based on forecasts obtained at year end and based on year-end prices -- Disadvantages of using reverse engineering based on prices at a particular point in time -- Determining virtual forecasted book values and virtual forecasted earnings at any date: the method proposed by Daske et al. (2006) -- An example: P&G -- Estimating earnings to the estimation date -- Estimating virtual book value -- Estimating earnings for the remainder of the fiscal period -- Discount daily -- An alternative: adjust prices -- Summary -- Some thoughts on future directions -- Other sources of earnings forecasts: the data -- Mitigating errors and bias -- Refocus on operations references updates.
Restrictions Restricted to subscribers or individual document purchasers.
Summary Estimating the Cost of Capital Implied by Market Prices and Accounting Data focuses on estimating the expected rate of return implied by market prices, summary accounting numbers, and forecasts of earnings and dividends. Estimates of the expected rate of return, often used as proxies for the cost of capital, are obtained by inverting accounting-based valuation models. The author describes accounting based valuation models and discusses how these models have been used, and how they may be used, to obtain estimates of the cost of capital.
Notes Peter Easton (2009) "Estimating the Cost of Capital Implied by Market Prices and Accounting Data", Foundations and Trends in Accounting: Vol. 2: No 4, pp 241-364.
Other formats Also available in print.
System notes Mode of access: World Wide Web.
System requirements: Adobe Acrobat reader.
Subject Capital costs -- Econometric models.
Rate of return -- Econometric models.
Valuation -- Econometric models.
ISBN 9781601981974 (electronic)
9781601981943 (print)
Standard Number 10.1561/1400000009