Analysts Earnings Forecasts and the Roles of Earnings and Book Value in Equity Valuation

This study examines the effect of the degree of association between current earnings and expected future earnings on the relative importance of earnings and book value for explaining equity price. Consensus analysts forecasts of one‐year‐ahead earnings are used to proxy for expected future earnings and are compared to reported current earnings to measure the degree of the association. We find that the value‐relevance of current earnings negatively correlates with the extent to which consensus analysts forecasts deviate from current earnings. We also find that the incremental explanatory power of book value for equity price positively correlates with this measure. These results remain robust after controlling for factors known to be affecting the value‐relevance of earnings such as negative earnings and the earnings‐to‐book ratio. Our results also show that this analysts' forecast‐based measure of `earnings persistence' dominates historical earnings variance in explaining cross‐sectional variations in the value‐relevance of earnings and book value.