Implied ROE on the Stockholm Stock Exchange:

University essay from Handelshögskolan i Stockholm/Institutionen för redovisning och finansiering

Author: Dag Wardaeus; John Byrge; [2010]

Keywords: Implied; ROE; RIV; reverse engineering;

Abstract: This thesis investigates the reasonableness of the expected returns on equity implied by the stock prices present in the bullish market of 2007 and the bearish market of 2009. With a sample of 66 companies listed on the Stockholm OMX Stock Exchange we deduct the implied return on equity expectations from a Residual Income Valuation model through reverse engineering. The reasonableness is evaluated through a statistical comparison between the resulting measures of implied expectations and how the companies have performed historically in terms of return on equity. The historical returns are hence used as a definition of reasonable expectations of future ROE. Through the analysis we conclude that the results in 2007 indicate that the prevailing prices are represented by return on equity expectations which are beyond the levels for which historical returns indicate reasonableness. For the results in 2009 we conclude that even though an extreme plunge in stock prices occurred, the expectations of companies´ future returns were still stuck at levels above reasonableness. The prevailing high levels of implied return on equity expectations in 2009 is partially explained by the increase in bankruptcy risk in the companies, which pushes prices down, while investors´ expectations of future operating performance are still higher than what is implied by historical measures.

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