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Errors and questionable judgments in analysts' DCF models
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DOI：10.1007/s11142-016-9352-4.png)
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We investigate the number of and reasons for errors and questionable judgments that sell-side equity analysts make in constructing and executing discounted cash flow (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 theory-related and/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 face-to-face interviews with analysts and those who oversee them, we conclude that analysts' DCF modeling behavior is semi-sophisticated in the sense that analysts genuinely make mistakes regarding certain aspects of correctly valuing equity but also respond rationally to the incentives they face, particularly the reality that they are not directly compensated for being textbook DCF correct.
Keyword:
Analysts
Sophistication
DCF
Valuation
Errors
Judgments
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On Comparing Cash Flow and Accrual Accounting Models for Use in Equity Valuation: A Response to Lundholm and O'Keefe (CAR, Summer 2001)关于比较现金流量和权责发生制会计模型以用于股权估值: 对Lundholm和O'Keefe的回应 (CAR，夏季2001)
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