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Uncertainty in firm valuation and a cross-sectional misvaluation measure

Bottazzi, Giulio, Cordoni, Francesco, Livieri, Giulia and Marmi, Stefano (2023) Uncertainty in firm valuation and a cross-sectional misvaluation measure. Annals of Finance, 19 (1). 63 - 93. ISSN 1614-2446

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Identification Number: 10.1007/s10436-022-00423-w

Abstract

The degree of uncertainty associated with the value of a company plays a relevant role in valuation analysis. We propose an original and robust methodology for company market valuation, which replaces the traditional point estimate of the conventional Discounted Cash Flow model with a probability distribution of fair values that convey information about both the expected value of the company and its intrinsic uncertainty. Our methodology depends on two main ingredients: an econometric model for company revenues and a set of firm-specific balance sheet relations that are estimated using historical data. We explore the effectiveness and scope of our methodology through a series of statistical exercises on publicly traded U.S. companies. At the firm level, we show that the fair value distribution derived with our methodology constitutes a reliable predictor of the company’s future abnormal returns. At the market level, we show that a long-short valuation (LSV) factor, built using buy-sell recommendations based on the fair value distribution, contains information not accessible through the traditional market factors. The LSV factor significantly increases the explanatory and the predictive power of factor models estimated on portfolios and individual stock returns.

Item Type: Article
Official URL: https://www.springer.com/journal/10436
Additional Information: © 2023 The Authors
Divisions: Statistics
Subjects: H Social Sciences > HB Economic Theory
H Social Sciences > HA Statistics
H Social Sciences > HG Finance
JEL classification: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
Date Deposited: 14 Feb 2023 16:24
Last Modified: 26 May 2024 04:06
URI: http://eprints.lse.ac.uk/id/eprint/118172

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