Keywords: Stock returns, equity premium, price-earnings ratio, earnings growth
Abstract: The long-term growth forecasts of equity analysts do not have
well-defined horizons, an ambiguity of substantial import for many
applications. I propose an empirical valuation model, derived from
the Campbell-Shiller dividend-price ratio model, in which the forecast
horizon used by the "market" can be deduced from linear regressions.
Specifically, in this model, the horizon can be inferred from the
elasticity of the price-earnings ratio with respect to the long-term
growth forecast. The model is estimated on industry- and sector-level
portfolios of S&P 500 firms over 1983-2001. The estimated
coefficients on consensus long-term growth forecasts suggest that the
market applies these forecasts to an average horizon of at least 6
years, and as many as 10 years.
Full paper (238 KB PDF)
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