Equity valuation in cyclical and acyclical industries

Abstract

This dissertation provides an overview of various valuation approaches, mainly the multiples-based approach, the Dividend Discount Model, Discounted Cash Flow Model, Residual Income Valuation Model and the Abnormal Earnings Growth Model. In addition, it highlights the advantages and disadvantages of each, and follows with a discussion of the models and evidence of empirical research. It then takes the angle of assessing the performance of selected valuation models (Price to Earnings multiple using one and two-year forecast earnings and the Residual Income Valuation Model) on companies in cyclical and acyclical industries. The results of the empirical research highlight the over performance of the multiples-based approach in both industry types as identified in this dissertation. Finally, a structured content analysis is conducted on a selection of thirty-two equity research reports from cyclical and acyclical industries. I examine the similarities and differences in the valuation methods used, in addition to analyst recommendations while taking into account the state of the economy. I also test the differences in the forecasted revenue growth rates and discount rates used in the valuations between the cyclical and acyclical subsamples. Results of equity report content analysis show that analysts, to a certain extent, do take into consideration the cyclicality of companies.