The aim of this master thesis is to understand if a firm’s dependency on the over-all business cycle impacts the performance of accounting-based valuation mod-els. I evaluated stock- and flow-based valuation models and their performance across cyclical and acyclical industries and found that multi-period flow-based models perform well for cyclical firms, while acyclical firms are more accurately valued via market multiples (P/E-multiple). In extension of the empirical findings, an analysis of valuation models used in analyst reports points out that practitioners do not necessarily employ the theoretically superior valuation technique to generate their target prices - while practically used and empirically superior valuation models are consistent in acyclical industries, they significantly differ in cyclical industries. Furthermore, the analysis in this master thesis highlights that analysts show the tendency to adopt different valuation models dependent on the actual cycle phase.
Table of Contents
1. Introduction
2. Review of Relevant Literature and Theory
2.1 Informational Content in Financial Statements
2.2 Discussion of Valuation Models
2.2.1 Fundamental Perspectives in Business-Valuation
2.2.2 Stock-Based Valuation Models (Market Multiples)
2.2.2.1 Identification of Comparable Firms
2.2.2.2 Computing the Benchmark Multiple
2.2.2.3 Selection of Relevant Value Drivers
2.2.3 Dividend Discount Model (DDM)
2.2.4 Residual Earnings Valuation Model (REVM)
2.2.5 Abnormal Earnings Growth Valuation Model (AEGM)
2.2.6 Option-Based Valuation Model
2.3 Discussion of Valuation Model Performance
2.4 Concluding Remarks
3. Large Sample Analysis
3.1 Research Question & Motivation
3.2 Original Data & Sample Selection
3.3 Research Methodology
3.3.1 Stock-Based Valuation
3.3.1.1 Selected Value Driver
3.3.1.2 Selection of Comparable Firms
3.3.1.3 Derivation of Benchmark Multiples
3.3.2 Flow-based Valuation
3.3.2.1 Cost of Capital (ρE)
3.3.2.2 Earnings Per Share (EPS) & forecasted EPS
3.3.2.3 Dividend Payout Rate (k)
3.3.2.4 Long Term Growth-Rate (g)
3.4 Empirical Results
3.4.1 Descriptive Statistics
3.4.2 Analysis of Valuation Errors
3.4.2.1 Intra-Sample Analysis of Valuation Errors
3.4.2.2 Cross-Sample Analysis of Valuation Errors
3.4.2.3 Difference in Valuation Errors between Valuation Models
3.4.2.4 Explanatory Power of Accounting-Based Valuation Models
3.5 Concluding Remarks on Empirical Results
4. Small Sample Analysis
4.1 Research Question & Aims
4.2 Data
4.3 Sample Selection
4.4 Methodology
4.5 Analysis of Primary Valuation Models
4.5.1 Models Employed in Valuing Acyclical Firms
4.5.2 Models Employed in Valuing Cyclical Firms
4.5.3 Summary of Analysts Ratings
4.5.4 Forecast Horizon in Reports on Acyclical and Cyclical Firms
4.5.5 Statements Focused by Analysts’ Forecasts
4.6 Concluding Remarks
5. Conclusion
Research Objectives and Key Topics
The primary aim of this thesis is to investigate whether a firm's dependency on the business cycle influences the performance and suitability of various accounting-based valuation models. The research evaluates both stock-based and flow-based models to determine which provide the most accurate value estimates across cyclical and acyclical industries, while also examining the valuation techniques and forecasting behaviors actually employed by financial practitioners.
- Comparative performance of stock-based vs. flow-based valuation models
- Valuation differences between cyclical and acyclical industry groups
- Influence of business cycle phases on analyst model selection
- Evaluation of analyst forecasting horizons and reporting behavior
- Practical vs. theoretical application of equity valuation techniques
Extract from the Dissertation
Stock-Based Valuation Models (Market Multiples)
Stock-based valuation models use a ratio of the current stock price to summary statistics from financial statements of comparable firms to generate a value estimate (Penman, 2008). Generally, these market multiples are considered to be the most common technique in equity valuation, widely used by analysts and investment bankers in reports, sell-side recommendations, fairness opinions, IPOs, LBOs, SEOs and other merger & acquisition transactions (Bhojraj & Lee, 2002). They are particularly important to the valuation of IPO’s, since most complex valuation models appear to be imprecise due to the difficulties in estimating valuation parameters (Kim & Ritter, 1999).
The immense popularity of multiples in valuation is mainly grounded on their simple derivation and application. Like more sophisticated valuation techniques, multiples rely on the assumption that value is an increasing function of future payoffs and a decreasing function of risk (Liu, Nissim, & Thomas, 2002). However, analysts embed both techniques in their reports using multiple-based valuations as implicit support of more complex models (Demirakos, Strong, & Walker, 2004).
By construction, multiples refer to market values, thus creating an indirect, market-based value estimate. Since all value estimates refer to a market variable, they reflect the mood of the market and need to be regarded as relative rather than intrinsic value estimates. This particular feature of multiple valuations assists investors to get a feeling for market values of privately held entities and plays a key role in the process of determining appropriate prices and price ranges for transactions (Penman, 2008).
Summary of Chapters
1. Introduction: Introduces the impact of business cycles on firm performance and the subsequent challenges for financial analysts regarding industry categorization and valuation.
2. Review of Relevant Literature and Theory: Provides the theoretical foundations by discussing the informational content of financial statements and outlining various stock-based and flow-based valuation models.
3. Large Sample Analysis: Empirically assesses the accuracy and bias of different valuation models when applied to a large dataset of cyclical and acyclical companies.
4. Small Sample Analysis: Examines actual analyst reports to determine which valuation models and forecasting behaviors are employed by practitioners during different phases of the business cycle.
5. Conclusion: Synthesizes the empirical findings and qualitative analysis, discussing the implications for valuation theory and identifying potential areas for future research.
Keywords
Equity Valuation, Business Cycle, Cyclical Industries, Acyclical Industries, Market Multiples, Residual Earnings Valuation Model (REVM), Abnormal Earnings Growth Valuation Model (AEGM), Financial Analysts, Forecast Accuracy, Analyst Forecasts, Valuation Models, Firm Performance, Valuation Bias, Discounted Cash Flow (DCF), Investment Recommendations
Frequently Asked Questions
What is the core subject of this research?
The research explores how the dependency of a firm on the business cycle affects the performance of various accounting-based valuation models and how these models are applied in practice by financial analysts.
What are the central thematic areas?
The key themes include the distinction between cyclical and acyclical industries, the theoretical versus practical performance of valuation models (such as P/E multiples, REVM, and AEGM), and the influence of economic cycle phases on analyst decision-making.
What is the primary objective of this dissertation?
The primary goal is to determine if a single valuation model can effectively capture intrinsic value for both industry groups or if different models are required, while also providing evidence on whether practitioners use the models that academics consider theoretically superior.
Which scientific methods are utilized?
The study employs a quantitative large-sample analysis using statistical regression and valuation error testing, complemented by a qualitative structured content analysis of analyst reports in the small-sample section.
What topics are covered in the main body?
The body covers a literature review of valuation theories, empirical testing of model accuracy and explanatory power across industry sub-samples, and an in-depth examination of analyst reports to observe real-world forecasting behavior and model selection.
Which keywords characterize the work?
Key terms include Equity Valuation, Cyclical Industries, Market Multiples, REVM, AEGM, Analyst Forecasts, and Business Cycle.
How do analysts' choices change based on the business cycle?
The analysis indicates that analysts tend to shift their preferences, moving toward more complex flow-based models during economic downturns and reverting to market-based multiples during phases of recovery and expansion.
What role does the collapse of Lehman Brothers play in the analysis?
The study notes that the period of economic contraction in the small-sample analysis coincided with the Lehman Brothers collapse, which created significant market volatility and rendered market-based valuations less meaningful for many firms during that specific time.
- Quote paper
- Konrad Leithäuser (Author), 2010, Advanced Topics in Accounting, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/166195
