Properties of implied cost of capital using analysts’ forecasts

Wayne Guay, Kothari Sp and Susan Shu

Australian Journal of Management, 2011, vol. 36, issue 2, 125-149

Abstract: We evaluate the influence of measurement error in analysts’ forecasts on the accuracy of implied cost of capital estimates from various implementations of the ‘implied cost of capital’ approach, and develop corrections for the measurement error. The implied cost of capital approach relies on analysts’ short- and long-term earnings forecasts as proxies for the market’s expectation of future earnings, and solves for the implied discount rate that equates the present value of the expected future payoffs to the current stock price. We document predictable error in the implied cost of capital estimates resulting from analysts’ forecasts that are sluggish with respect to information in past stock returns. We propose two methods to mitigate the influence of sluggish forecasts on the implied cost of capital estimates. These methods substantially improve the ability of the implied cost of capital estimates to explain cross-sectional variation in future stock returns, which is consistent with the corrections being effective in mitigating the error in the estimates due to analysts’ sluggishness.

Date: 2011
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (39)

Downloads: (external link)
https://journals.sagepub.com/doi/10.1177/0312896211408624 (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:36:y:2011:i:2:p:125-149

DOI: 10.1177/0312896211408624

Access Statistics for this article

More articles in Australian Journal of Management from Australian School of Business
Bibliographic data for series maintained by SAGE Publications ().