Using earnings forecasts to simultaneously estimate firm-specific cost of equity and long-term growth

Alexander Nekrasov () and Maria Ogneva ()
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Alexander Nekrasov: University of California, Irvine
Maria Ogneva: Stanford University

Review of Accounting Studies, 2011, vol. 16, issue 3, No 2, 414-457

Abstract: Abstract A growing body of literature in accounting and finance relies on implied cost of equity (COE) measures. Such measures are sensitive to assumptions about terminal earnings growth rates. In this paper we develop a new COE measure that is more accurate than existing measures because it incorporates endogenously estimated long-term growth in earnings. Our method extends Easton et al. (J Account Res, 40, 657–676, 2002) method of simultaneously estimating sample average COE and growth. Our method delivers COE (growth) estimates that are significantly positively associated with future realized stock returns (future realized earnings growth). Moreover, the predictive ability of our COE measure subsumes that of other commonly used COE measures and is incremental to commonly used risk characteristics. Our implied growth measure fills the void in the earnings forecasting literature by robustly predicting earnings growth beyond the five-year horizon.

Keywords: Cost of equity; Expected return; Expected earnings growth; Residual income model (search for similar items in EconPapers)
JEL-codes: G12 G14 G17 G31 M41 (search for similar items in EconPapers)
Date: 2011
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DOI: 10.1007/s11142-011-9159-2

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