The role of investment beliefs and heuristics in corporate valuation

Abstract

Purpose – The purpose of this study is to gain an understanding of the different cognitive processes of buy-side and sell-side financial analysts and their use of investment beliefs and heuristics to mitigate risk and uncertainty when analyzing companies. Design/methodology/approach – A mixed methods approach and a thematic analysis have been conducted based on 20 semistructured interviews with both buy-side and sell-side financial analysts. Using a think-aloud technique, the respondents formulated their thoughts aloud when analyzing a company and rated the importance of different financial and nonfinancial key measures along with their preferred analysis approaches, source preferences and information usage. Findings – Buy-side and sell-side financial analysts share similar investment beliefs. Both perceive the stock market as irrational and unpredictable. Both groups also focus on companies’ nonfinancial information such as business models, ownership structure and governance while they distrust sustainability rankings. Buy-side analysts emphasized unpredictability and the limitations of expertise. Sell-side analysts focused on controlling corporate risks rather than reflecting on the limitations of the investment process to consider the systematic and inherent market risks. These differences are suggested to be explained by differences in scope and expertise – buy-side analysts being generalists and sell-side being specialists. Originality/value – The present study is among the few that compares sell-side and buy-side financial analysts’ valuation processes by using semistructured interviews and a think-aloud approach. It shows that buy-side analysts share a skepticism toward sell-side analysts’ judgments and recommendations, and especially the credibility and validity of Environmental, Social and Governance issues (ESG) rankings. The study also reveals differences in cognitive approaches to valuation of companies.