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An International Meeting of American Accounting
Association
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Bias in Expected Rates of Return Implied by Analysts' Earnings Forecasts |
Peter D. Easton
University of Notre Dame
Gregory A. Sommers
Southern Methodist University
Abstract: In this paper, we determine this difference between the implied analysts’ expected rate of return and the market expectation. Our estimate of the market expected rate of return is the rate implied by market prices, book value of common equity, and recently announced actual earnings. We show that, on average, the estimate of the difference between the estimate of the implied analysts’ expected rate of return and the estimate of the market expectation is 3.35 percent and there are some years when it is quite large (for example, for the sample of stocks in 1994, the estimate of the difference is 4.77 percent). An implication of the observation that analysts tend to forecast rates of return that are higher than market expectations is that caution should be taken when interpreting the meaning of the rate of return that is implied by analysts’ earnings forecasts: it may not be, as the literature generally claims, an estimate of the cost of capital.