Constructing Intrinsic Value Estimates of Equity Using IBES and Value Line Forecasts of Fundamentals
Lucie Courteau, Philip Gray, Jennifer L. Kao, Terry O'Keefe, Gordon D. Richardson
Social Science Research Network
The purpose of this paper is to determine how to produce best estimates of intrinsic value, as measured by 36 month abnormal returns, using IBES only forecasts, VL only forecasts, or forecasts from both services. IBES only provides earnings forecasts, while VL provides forecasts of earnings, book value, cost of capital and terminal value forecasts. We estimate 14 intrinsic value models, constructed by linking IBES and VL forecasts to the residual income model (RIM), Forward Price Earnings
... and hybrid models, where hybrid models are the average of a RIM and an a FPE model. The best "VL only" model is a RIM model which earns an abnormal return of (.0141), the best "IBES only" model is the IBES-FPE model earning (-.0169), and the best "both VL and IBES" model is a hybrid model using based on IBES earnings forecasts and VL's terminal value forecasts, earning (.0037). None of these returns differ statistically from zero or from each other. The remaining models earn medium to large negative returns. Given the existence of acquisition costs, it is cost effective for an analyst to either purchase VL forecasts for use in a VL only RIM model, or to purchase IBES forecasts for use in the IBES-FPE model. If the objective is maximization of raw returns, the best "VL only" model for estimating intrinsic price is a RIM model that earns a statistically significant (.1069) raw return, the best "IBES only" model is the IBES-FPE model earning (.0451), and the best "both VL and IBES" model is a RIM model based on IBES earnings forecasts and VL's terminal value forecasts, that earns a statistically significant (.1018) raw return None of the other models earn statistically significant raw returns. Given the existence of acquisition costs, it is cost effective for an analyst to purchase VL forecasts for use in a VL only RIM model. We expanded the analysis to consider which models are most consistent with how investors set current price. A hybrid model based on IBES earnings forecasts and VL's terminal value forecasts is most consistent with current price. This implies that investors incorporate both IBES earnings and VL forecasts of terminal value in their estimates of intrinsic price. It's intuitive that analysts would like to see forecasts from both IBES and VL when beginning their own intrinsic value analysis.