Analysts’ estimates of cost of equity capital

Accounting

Social Sciences Research Network

Balakrishnan K; Shivakumar L; Taori P

Lakshmanan Shivakumar

2018

We explore a large sample of analysts’ estimates of cost of equity capital (CoE) revealed in analysts’ reports to evaluate their determinants and ability to capture expected stock returns. We find that the CoE estimates strongly predict future stock returns and are significantly related to beta, size, book-to-market ratio, leverage and short-term return reversals but not to profitability, investments or other return predictors. These estimates also incrementally predict future returns after controlling for known return predictors. Consistent with financial distress being a risk factor, analysts appear to increase their CoE estimates following negative earnings news. Finally, based on a pair-wise comparison of CoE estimates with alternative expected return proxies (estimated from CAPM, Fama-French factor models or implied cost of capital models), we find that CoE estimates tend to be least noisy. We conclude that analysts’ CoE estimates are good proxies of expected stock returns and, where available, are a useful alternative to commonly used expected return proxies.

Analysts; Expected Stock Returns; Discount Rates; Cost of Equity

Social Sciences Research Network

No

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