Valuation Is Vibes
Fund managers say they are doing models, but most of it comes down to gut feelings about CEOs in short meetings.
As alluded to in the previous post about financial markets being a battleground for financial expertise, which in turn influences capital markets, the following studies bring up additional findings relevant to the field of investment advice. After reading them, I thought I would share some insights with you.
Millo, Spence, and Valentine (2023)—the same authors who wrote the study on active vs. passive fund managers discussed in the prior post—attempt to address a long-standing conundrum in the literature on equity analysts: they are both seen as influential market participants yet are frequently criticized for their bias and inaccuracy.
Based on 70 interviews with analysts and fund managers in the UK and US, the study reframes analysts not as mere economic agents providing information but as actors embedded in a social field. By doing so, the authors formalize the idea that the persistence of equity analysts, despite widespread skepticism about their value, is sustained by interpersonal and interinstitutional ties between buy-side and sell-side actors. Analysts’ relationships with buy-side clients, their access to corporate executives, and conflicts of interest arising from the corporate finance services offered by their investment banks (i.e., their employers) create sticky social ties that reinforce their position—even when their analyses are seen as inaccurate or biased. The researchers refer to this relational stickiness as social inertia in the field of investment advice. As they put it, the field of investment advice is “very much like any other in the sense that cultural norms and social bonds act simultaneously as important drivers of stability and barriers to change and innovation.”
Another key insight from the study challenges the prevailing narrative that analysts are a homogeneous group, instead identifying them as highly heterogeneous. Analysts face a tension between conforming to consensus estimates (to avoid reputational risk, as it is better to be wrong when conforming) and strategically diverging to signal expertise. Those who deviate too far from consensus risk marginalization, while those who skillfully distance themselves are perceived as part of an “elite” group.
Of the three papers discussed here, the study by Barker, Hendry, Roberts, and Sanderson (2012) is undoubtedly the most intriguing. It critically examines the informational value of private meetings between UK fund managers and corporate executives. Conventional economic theory assumes that useful information is synonymous with price-sensitive information, and market regulations prohibit the selective disclosure of such price-sensitive details. Yet, despite this apparent contradiction, fund managers continue to regard these meetings as their most important source of investment information.
The paper offers three key theoretical explanations for this paradox. First, it argues that the definition of useful information in economic theory is too narrow. The study highlights the role of tacit knowledge, subjective judgment, and non-quantifiable insights that fund managers derive from these meetings, particularly concerning long-term corporate performance and management quality. Since much of this information is not directly price-sensitive yet still influential in shaping investment decisions, the authors challenge the neoclassical assumption that only explicit, publicly available information matters.
Second, the study suggests that fund managers may irrationally overestimate the informational value of these meetings. Given the brevity, formulaic structure, and controlled nature of these interactions, it is questionable whether they genuinely provide a competitive advantage. Fund managers rely heavily on subjective impressions of management competence, leadership style, and behavioral cues, yet the paper raises doubts about the reliability of these assessments. Given how rehearsed corporate messaging often is, the findings suggest that fund managers may be prone to confirmation bias, overconfidence, or an illusion of control when interpreting these discussions.
Third, the paper introduces the principal-agent problem as an alternative explanation. Rather than primarily serving an informational function, these meetings may be more about fund managers signaling their expertise and justifying their active management fees to clients. By claiming privileged access to company executives, fund managers differentiate themselves from passive investment strategies, even if such access does not necessarily translate into superior investment performance. This contributes to a broader agency issue, where fund managers extract value from client fees while maintaining a narrative of informational advantage.
Before moving on to the next paper, let’s pause to consider the practical implications of fund managers' reliance on these meetings. The study clearly distinguishes between short-term forecasting (roughly two years)—where fund managers, based on their interviews with CFOs, generally make reasonably accurate predictions—and long-term forecasting, where they do not, simply because management decisions that will shape future performance have yet to be made. If those decisions are yet to be formulated, neither the CEO nor the CFO knows what will happen—hence, nor can the fund managers. And here lies the issue: for any period beyond two years, fund managers’ revenue, cost, and profit forecasts—the core inputs into their valuation models—are largely based on their personal assessment of the CEO/CFO team.
To illustrate this, let’s take a simple DCF example. Assume a business with annual revenue of $100m, total costs of $50m, and annual cash flow of $50m. For simplicity, assume no growth in the forecast period (years 1–5) and a zero terminal growth rate. With a 10% discount rate, the present value of cash flows from years 1–5 is $189.5m, while the present value of the terminal value at year 0 is $310.5m, leading to a total valuation of $500m. And just to be clear—I know this could be calculated more directly as $50m/0.1 = $500m, but the breakdown is necessary for my argument. Now, looking at the first two years alone, their PV is $86.8m, meaning that the remaining $413.2m ($500m - $86.8m), or 82.6% of the total value, comes from cash flows beyond year 2. If we had assumed growth, this percentage would be even higher.
Now, let’s tie this back to the study’s key finding: fund managers place immense faith in their ability to assess the CEO/CFO team and, from that assessment, infer the company’s future performance. In our example, that "future performance" accounts for 82.6% of the business’s total value. And how do fund managers derive this assessment? From subjective judgments made during a one-hour meeting that takes place either once a year or every six months.
These are extraordinarily strong claims, to say the least.
Let’s conclude this post by discussing the third and final paper. Although it has been around for a long time, I had not come across it before, as I am new to this research field. I chose to read it because it was written by Richard G. Barker, one of the authors of the study discussed earlier. At the time of this study, he was at Cambridge University, but he is now at Oxford.
Barker (1999) explores the role of dividends in the valuation models used by equity analysts and fund managers, questioning why theoretical models like the dividend discount model (DDM) play a minor role in practice while simpler valuation heuristics, such as the dividend yield and price-earnings ratio (PE), dominate investment decision-making. Drawing on fieldwork that includes participant observation, surveys, and interviews with analysts, fund managers, and finance directors in the UK, the study sheds light on how dividends are actually incorporated into valuation and investment processes.
A key finding is that valuation in practice departs significantly from financial theory. While the DDM theoretically determines a share’s price based on future dividends, fund managers and analysts rarely attempt to forecast dividends beyond a two-year horizon due to the inherent uncertainty of corporate decision-making—a timeframe that, as noted earlier, aligns with the findings from the previously discussed study. Instead, they base their long-term valuation judgments on short-term dividend forecasts combined with qualitative assessments of management quality—an approach that closely aligns with the findings of the 2012 study. The study highlights that the subjective estimation of terminal value—which typically accounts for the majority of a firm's total valuation—is largely driven by perceptions of the CEO and CFO’s competence, as I illustrated in my simple DCF valuation above.
Another major contribution of the paper is its exploration of the signaling function of dividends. Rather than using dividends strictly as inputs into valuation models, fund managers view them as part of a dynamic process of implicit contracting between companies and investors. The study provides evidence that finance directors strategically manage dividend policies to signal confidence in future earnings and maintain credibility with investors. In this context, dividend yield serves as a benchmark for identifying relative pricing differences rather than as a direct valuation tool. This finding aligns with research on information asymmetry and corporate disclosure, illustrating how dividend policy acts as a mechanism for firms to shape market expectations.
The study ultimately challenges the assumption that investment valuation is driven by formal, rational, and sophisticated models. Instead, it emphasizes how valuation is shaped by institutionalized practices, interpersonal interactions, and subjective assessments of managerial ability—an observation that, once again, aligns with the findings of the 2012 study. Practitioners favor ‘unsophisticated’ valuation methods due to the difficulty of forecasting future cash flows. This constraint limits the quantitative foundation of valuations to short-term horizons, leaving the terminal value to be assessed subjectively and qualitatively—ultimately making it a crucial determinant of overall valuation.
Bibliography
Barker, R. (1999) ‘The role of dividends in valuation models used by analysts and fund managers’, The European Accounting Review, 8(2), pp. 195–218.
Barker, R., Hendry, J., Roberts, J. and Sanderson, P. (2012) ‘Can company-fund manager meetings convey informational benefits?’ Exploring the rationalisation of equity investment decision making by UK fund managers, Accounting, Organizations and Society, 37, pp. 207–222.
Millo, Y., Spence, C. and Valentine, L. (2023) ‘The Field of Investment Advice: The Social Forces That Govern Equity Analysts’, The Accounting Review, 98(7), pp. 457-477.