Valuation Methods used by UK analysts : are their Target Prices eHective in predicting stock prices in the European energy sector?

Abstract

This dissertation aims to find out if the current valuation methods used by sell-side equity research analysts result in accurate target price predictions for the European energy sector. To do this, we must first understand the energy sector’s current and future environment. Then, answer why valuation is important and the assumptions behind the valuation methods used. Moreover, a review of the practical reality on the application of valuation methodology is paramount to get a grasp for the process the analysts go through when determining their target prices. Finally, we test analysts´ target price accuracy through a sample of 250 equity research reports from three different Investment Banks for four of the leading European utilities industry: Iberdrola (Spain), Centrica (UK), E.ON (Germany) and EDF (France). Two measures of target price accuracy are measured: the absolute forecast error and the absolute value difference between target price and current price. The findings based on the study show that: (i)There is clear evidence that the DCF has established itself as the most prominent valuation method used by analysts to estimate the value of energy companies (88%). (ii) However, regarding target price, the results indicate that the DCF does not provide accurate target prices, which is backed up by the existing literature. (iii) Regarding the best valuation method to use, the only conclusive evidence is that the DCF should not be used for target price accuracy.