Journal of Accounting Research Vol. 37 No. 2 1999
On the Theory of Forecast Horizon in Equity Valuation
Abstract
Forecasting a firm's anticipated financial performance is an essential ingredient in equity valuation. In practice, analysts generally split the forecasting into two stages. The first stage develops relatively detailed forecasts of financial statement line items up to some preselected horizon date. (Casual observation suggests that the horizon rarely exceeds 15 years.) The second stage considers forecasts beyond the horizon date. Analysts now tend simply to extrapolate the selected valuation attribute (like dividends, cash flows, or [residual] earnings). Thus a single growth/ decay parameter determines the expected evolution of the valuation attribute in periods subsequent to the horizon year. On the basis of these two sets of forecasts, analysts then apply present value calculations to estimate a firm's intrinsic value. The portion of value due to the posthorizon period is generally referred to as the continuing (or terminal) value. Textbooks, such as Copeland, Koller, and Murrin [1994] and Damodaran [1994; 1996], illustrate how one implements these valuation approaches. Though the use of a horizon date is always present, its influence on the analysis is less than apparent. The idea behind the horizon concept seems to be that posthorizon simplifications introduce only minor valuation errors. That is, the less refined analysis of information is, in the grand scheme of things, relatively inconsequential and thus costbenefit effective.
- DOI
- 10.2307/2491416
- Volume
- 37
- Issue
- 2
- Pages
- 437
- Sources
- bibtex:phds-export.bib openalex crossref