Persistence and predictability of analyst bias in forecasts of price-earnings ratios: a decomposition of target price error

Parslow, Edward (2012). Persistence and predictability of analyst bias in forecasts of price-earnings ratios: a decomposition of target price error Honours Thesis, UQ Business School, The University of Queensland.

       
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Author Parslow, Edward
Thesis Title Persistence and predictability of analyst bias in forecasts of price-earnings ratios: a decomposition of target price error
School, Centre or Institute UQ Business School
Institution The University of Queensland
Publication date 2012-10
Thesis type Honours Thesis
Supervisor Jason Hall
Total pages 94
Language eng
Subjects 1502 Banking, Finance and Investment
Abstract/Summary Target prices are not an independent output of equity analysts but are dependent upon and related to earnings forecasts that accompany them. As a result, target prices can be stated as a function of both earnings forecasts and the price-earnings (PE) ratios at which those earnings are capitalised. I investigate whether error in target prices is attributable to separable, inde-pendent error in earnings forecasts and PE ratios, or whether PE ratios are unbiased and target price error is simply a mechanical function of variation in earnings forecasts. Using a novel methodology, I decompose target price error into PE-attributable and earnings-attributable components, generate an estimate from this of actual PE ratio error measured in multiples and investigate the variation in this PE ratio error over time and in the cross section. I find that a large proportion of target price error is attributable to error in PE ratio forecasts. I find that over time, the PE ratio error of the analyst community as a whole is driven by changes in stock returns that are unforseen by analysts. I find that overestimation of the PE ratio in the cross-section increases in optimism that is relatively long-term, decreases in optimism that is relatively short-term and increases in contemporaneous stock returns, as a result of the high returns earned by value stocks that trade at low PE ratios. Finally, I find that individual ana-lysts exhibit highly significant persistence in their overestimation of PE ratios.

 
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Created: Fri, 21 Dec 2012, 14:23:07 EST by Karen Morgan on behalf of UQ Business School