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Asper Professor’s Work Accepted by Financial Times top 50 Journal

Study indicates that analyst valuation process reflects the demand investors have for solid information

March 7, 2022 — 

Not much is understood about how financial analysts convert forecasts into investment opinions. And most accounting researchers don’t include the textual information in analyst reports when conducting a study. Asper School of Business Accounting and Finance Assistant Professor and CPA Research Fellow, Dr. Changqiu Yu and co-authors Shengzhong Huang, Hongping Tan and Xiongyuan Wang examine how analysts process information to justify their recommendations and target prices. Their paper titled Valuation uncertainty and analysts’ use of DCF models was recently accepted by Review of Accounting Studies, a Financial Times top 50 publication which provides an outlet for significant academic accounting research including theoretical, empirical and experimental work.

“This research project has been several years in the making and I am very proud of and grateful for my team, said Yu. “We collaborated through changes to our lives and careers brought by the pandemic, and revised until we felt that we were delivering our best work to the field.”

Yu’s study found that instead of a price-to-earnings (PE) model, analysts are more likely to use a discounted cash flow (DCF) model—that explicitly discusses more of the information on cash flows and discount rates—for firms with more uncertainty, as measured by lower earnings quality and the higher number of risks a firm takes. A DCF model uses more specific information and can better answer investor demand for this added level of context, which in turn generates stronger investor reactions, since it heightens analysts’ justification of their opinions.

“Analysts’ valuation process is a ‘black box’. We know little about the valuation process through which analysts convert earnings and various other accounting metrics into target prices and stock recommendations,” said Yu. “Our study is important as it explores the impact of a firm’s valuation uncertainty in cash flow and discount rate information on analysts’ expression of such value-relevant information by using DCF models.”

The study used textual analysis for a large sample of analyst reports on U.S.-based firms and suggests that DCF valuation is valuable to investors for firms with greater uncertainty, and when accompanied by granular information. The results indicate that the analyst valuation process reflects the demand investors have for solid information when things are uncertain, which matters when measuring exactly how informative analyst research is.

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