Purpose

The purpose of this paper is to explore the industry-specific preferred valuation model utilised by analysts’ in determining a stock’s target price. By understanding analysts’ use of industry-specific valuation models, we can enhance our comprehension of important aspects of value creation in these sectors. Therefore, understanding the industry context is crucial for accurately assessing the value of companies within that industry and selecting the most suitable valuation model.

Design/methodology/approach

The method employed in this study is content analysis, examining the output of analysts’ valuation models within 25 Global Industry Classification Standard (GICS) industry groups. I hand-collected 806 equity reports from Capital IQ, selecting the four companies with the largest market capitalization from each of the 25 industry groups.

Findings

Price/Earnings (P/E) emerges as the preferred valuation model in 20 out of the 25 industry groups based on the GICS, with some exceptions. Notably, EV/EBITDA is favoured in the telecom, energy and materials sectors, while the capital goods industry primarily relies on Price/Cash flow (P/CF). In the Real Estate Investment Trusts (REITs) sector, P/AFFO (adjusted funds from operations) is the most commonly employed model. While earnings multiples remain the favoured valuation model for financial analysts, a noticeable shift away from multiperiod valuation models is evident after the first decade of the 21st century.

Research limitations/implications

The findings can increase our comprehension of the interplay between valuation methodologies, industry characteristics and investment decision-making.

Practical implications

It establishes a foundation for future research in this field and is anticipated to be of interest to analysts, fund managers and investors. The findings can increase our comprehension of the interplay between valuation methodologies, industry characteristics and investment decision-making.

Originality/value

This paper represents the first systematic and comprehensive examination of analysts’ utilisation of industry-specific stock valuation methods across all 25 GICS industry groups.

Purpose

Surprisingly little is known of the various methods of security analysis used by financial analysts with industry-specific knowledge. Financial analysts’ industry knowledge is a favored and appreciated attribute by fund managers and institutional investors. Understanding analysts’ use of industry-specific valuation models, which are the main value drivers within different industries, will enhance our understanding of important aspects of value creation in these industries. This paper contributes to the broader understanding of how financial analysts in various industries approach valuation, offering insights that can be beneficial to a wide range of stakeholders in the financial market.

Design/methodology/approach

This paper systematically reviews existing research to consolidate the current understanding of analysts’ use of valuation models and factors. It aims to demystify what can often be seen as a “black box”, shedding light on the valuation tools employed by financial analysts across diverse industries.

Findings

The use of industry-specific valuation models and factors by analysts is a subject of considerable interest to both academics and investors. The predominant model in several industries is P/E, with some exceptions. Notably, EV/EBITDA is favored in the telecom, energy and materials sectors, while the capital goods industry primarily relies on P/CF. In the REITs sector, P/AFFO is the most commonly employed model. In specific sectors like pharmaceuticals, energy and telecom, DCF is utilized. However, theoretical models like RIM and AEG find limited use among analysts.

Originality/value

This is the first paper systematically reviewing the research on analyst’s use of industry-specific stock valuation methods. It serves as a foundation for future research in this field and is likely to be of interest to academics, analysts, fund managers and investors.

Financial analysts use different valuation models across various industries in stock valuation. Each industry has unique characteristics that influence the choice of valuation models. Analysing the models used by analysts in different industries enhances investors’ understanding of company valuation within those sectors and helps identify investment opportunities and risks. This understanding is crucial for investors seeking to compare companies within the same industry, as it directly impacts the assessing of a company's intrinsic value and the identification of investment opportunities. 

The overall purpose of this thesis is to explain how industry affects analysts’ use of valuation models in determining a stock’s target price. A secondary purpose is to explore whether analysts have increased or decreased their use of multiperiod valuation models in stock valuation and whether major textbooks adequately incorporate research results in the areas of security and financial statement analysis. 

This thesis consists of a compilation of four papers and a comprehensive summary. Paper I constitutes a literature review with the primary objective of scrutinising the valuation models employed by analysts across different industries. Paper II, published in 1994, builds upon my licentiate thesis, and is based on a questionnaire directed to Swedish financial analysts regarding their use of valuation models and information sources. Paper III is based on content analysis of financial analysts’ equity reports covering the largest companies from 25 industry groups. In Paper IV, I examined textbooks within the domain of security and financial statement analysis. This examination aimed to assess whether these major textbooks referenced relevant research findings from areas associated with security and financial statement analysis. 

The results from the empirical study in Paper II revealed that the predominant model was P/E. In Paper III I found that P/E was the preferred valuation model in 20 of the 25 industry groups, with exceptions being EV/EBITDA in telecom, energy, and materials. P/CF was the number one choice in capital goods, and finally, P/AFFO was utilized most within the REITs sector. In Paper IV I found that many important empirical research results that could enhance valuation models were not covered in major textbooks. I identified specific areas where researchers, educators, and practitioners can collaborate to bridge the gap between theory and empirical research results. 

Finansanalytiker använder olika värderingsmodeller branscher inom aktievärdering beroende på branschtillhörighet. Varje bransch har unika egenskaper som påverkar finansanalytikerns val av värderingsmodeller. Genom att förstå vilka modeller som analytiker använder inom olika branscher kan investerares förståelse för aktievärdering förbättras inom dessa sektorer, vilket hjälper till att identifiera både investeringsmöjligheter och risker. Denna insikt är avgörande för de investerare som vill jämföra företag inom samma bransch, då det direkt påverkar ett företags fundamentala värde.

Det övergripande syftet med avhandlingen är att förklara hur branschtillhörighet påverkar analytikers användning av värderingsmodeller vid beräkning av en akties riktkurs. Ett sekundärt syfte är att undersöka om analytiker har ökat eller minskat sin användning av diskonterade kassaflödesmodeller vid aktievärdering och om läroböcker inkluderar forskningsresultat inom aktievärdering.

Avhandlingen består av fyra artiklar och en sammanfattande kappa. Artikel I innehåller en litteraturöversikt där syftet är att beskriva vilka värderingsmodeller som används av finansanalytiker inom olika branscher. Artikel II, publicerad 1994, utgår från min licentiatavhandling och baseras på en enkät riktad till svenska finansanalytiker och är fokuserad på deras användning av värderingsmodeller och informationskällor. Artikel III baseras på en innehållsanalys av finansanalytikers rapporter, vilket inkluderar de största företagen från 25 branscher. I artikel IV studerade jag om relevanta forskningsresultat inom aktievärdering var redovisade i läroböcker inom området.

Resultaten från den empiriska studien i artikel II visade att den dominerande värderingsmodellen var P/E. I artikel III fann jag att P/E var den dominerande värderingsmodellen i 20 av de 25 branscherna, med undantag för EV/EBITDA inom branscherna telecom, energy och materials. P/CF var förstahandsvalet inom capital goods och slutligen användes P/AFFO mest inom REIT-sektorn. I artikel IV fann jag att många relevanta empiriska forskningsresultat relaterade till aktievärdering inte inkluderades i läroböckerna.  

Although research results can enhance the content of education programs at various university levels, many important research results are only partly covered in major university-level textbooks. It is more difficult to transfer contributions from research results to practitioners if the former is not part of regular education programs. Here, we identify areas where researchers and educators can bridge the gap between theory and research results based on empirical studies, allowing findings to be more easily implemented by practitioners in situations that can improve their output. We take the use and accuracy of security and financial statement analysis as our prime target to examine empirical research results. Financial statement analysis and security valuation are two important applications in accounting and finance, and it is possible to measure changes in the models’ parameters and the effect these have on the outcome. We focus on five aspects of security and financial statement analysis: analysts’ use of valuation models, their estimates and accuracy, peer selection using multiples, valuation models target price accuracy, and differences in industry-specific valuation models and valuation factors. We find that most of the important research results are not referenced in major financial accounting textbooks.