Does the reliability of the intrinsic equity value estimates derived from a multiple-based model and three flow-based models differ?

Abstract

I investigate the valuation performance of one multiple-based valuation model using 1-year ahead consensus forecasted earnings as a value driver and of three flow-based valuation models – dividend discount model, discounted cash flow model and residual income valuation model. To conduct the analysis, 2,856 observations of U.S. public companies from 2005 to 2015 are considered. Each observation is assessed for bias, accuracy and explainability utilizing t-tests, Wilcoxon sign-rank tests and ordinary least squares regressions. Opposite to prior research, I find that the multiple-based valuation model performs best in all performance measures, followed by the residual income valuation model. The discounted cash flow model is contemplated as superior to the dividend discount model, even though they sometimes alternate their order of superiority. Concerning the impact of the R&D expenditure on the performance of the models, all the flow-based valuation models perform best in a low R&D context, while the multiple-based valuation model performs best in a high R&D context. Still, the models’ performance ranking prevails regardless of the R&D expenditure. To evaluate the robustness of the results to the models’ implementation issues, sensitivity analyses for the market risk premium, growth rate, forecast horizon, selection of comparable companies and the method of computing the benchmark multiple are executed, which evidences that the models’ performance ranking is robust to each assumption alteration, except for the lowest levels of the market risk premium where the least sensitive model, the DDM, outperforms within the flow-based valuation models. These findings are tested in reality by analysing two sell-side equity analyst reports for The Walt Disney Company (NYSE: DIS). In line with the main analysis, the appraised analysts seem to prefer the multiple-based valuation model to estimate a target price. However, this evidence based on one individual case company cannot be generalized. To conclude, this dissertation underlines the multiple-based valuation model’s superiority over all the flow-based valuation models in estimating equity value in a modern environment.

Date of Award	3 Dec 2021
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Paulo Alves (Supervisor)