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Errors and questionable judgments in analysts’ DCF models

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John R. M. Hand is the H. Allen Andrew Distinguished Professor at UNC Kenan-Flagler. With wide ranging interests in accounting, entrepreneurship and finance, , Dr. Hand’s current research focuses on equity analysts’ financial statement forecasts and valuation models, the identities and economic importance of multidimensional stock return predictive signals, and what hedge funds tell their investors. He is co-author of “Intangible Assets: Values, Measures and Risks” (Oxford University Press, 2003) with Baruch Lev of New York University.


We investigate the number of and reasons for errors and questionable judgments that sell-side equity analysts make in constructing and executing DCF equity valuation models. For a sample of 120 DCF models detailed in reports issued by U.S. brokers in 2012 and 2013, we estimate that analysts make a median of three theoretic or execution errors and four questionable economic judgments per DCF . Recalculating analysts‘ DCFs after correcting for major errors changes analysts‘ mean valuations and target prices by between -2% and 14% per error. Based on a combination of regression analysis and face-to-face interviews with analysts and those who oversee them, we conclude that analysts‘ DCF modelling behavior is semi-sophisticated in that analysts both genuinely make mistakes regarding certain aspects of correctly valuing equity, but also respond rationally to the incentives they face, particularly that they are not directly compensated for being textbook DCF correct.

This talk is part of the Finance & Accounting Seminar Series series.

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