Errors and questionable judgments in analysts’ DCF models

Jeremiah Ross Green, John R.M. Hand, X. Frank Zhang

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

We investigate the number of and reasons for errors and questionable judgments that sell-side equity analysts make in constructing and executing discounted cash flow (DCF) equity valuation models. For a sample of 120 DCF models detailed in reports issued by U.S. brokers in 2012 and 2013, we estimate that analysts make a median of three theory-related and/or execution errors and four questionable economic judgments per DCF. Recalculating analysts’ DCFs after correcting for major errors changes analysts’ mean valuations and target prices by between −2 and 14 % per error. Based on face-to-face interviews with analysts and those who oversee them, we conclude that analysts’ DCF modeling behavior is semi-sophisticated in the sense that analysts genuinely make mistakes regarding certain aspects of correctly valuing equity but also respond rationally to the incentives they face, particularly the reality that they are not directly compensated for being textbook DCF correct.

Original languageEnglish (US)
Pages (from-to)596-632
Number of pages37
JournalReview of Accounting Studies
Volume21
Issue number2
DOIs
StatePublished - Jun 1 2016

Fingerprint

Analysts
Discounted cash flow
Equity
Median
Modeling
Incentives
Target price
Textbooks
Equity valuation
Economics
Broker
Valuation model

All Science Journal Classification (ASJC) codes

  • Accounting
  • Business, Management and Accounting(all)

Cite this

Green, Jeremiah Ross ; Hand, John R.M. ; Zhang, X. Frank. / Errors and questionable judgments in analysts’ DCF models. In: Review of Accounting Studies. 2016 ; Vol. 21, No. 2. pp. 596-632.
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Errors and questionable judgments in analysts’ DCF models. / Green, Jeremiah Ross; Hand, John R.M.; Zhang, X. Frank.

In: Review of Accounting Studies, Vol. 21, No. 2, 01.06.2016, p. 596-632.

Research output: Contribution to journalArticle

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