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Ex Ante Adjustments for One-Period Ahead Earnings Forecasts
Mingcherng Deng, Columbia Business School
Julian Yeo, Columbia Business School
ABSTRACT. Price-multiples with expected earnings (e.g., forward P/E and PEG ratio) are commonly used investment heuristics in the financial press. When using one-period ahead earnings forecast to select or rank stocks, it is important to understand (i) the extent to which stock prices reflect adjustments to these potentially optimistically biased earnings forecasts and (ii) the circumstances where these forecasts are typically adjusted. Using our estimation procedure, we find that one-period ahead earnings are adjusted downwards, on average, by approximately 10%. We also show that some risk-return proxies (such as market capitalization and prior period returns) and information content of forecasts (such as analyst followings, forecast dispersions and lagged forecast errors) explain our measure of ex ante forecast adjustments. Investors do not appear to weigh accounting attributes heavily in their adjustment of the more distant earnings forecasts.
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