Equity Valuation : Forecasting Earnings Based on Probability Distributions Linked to Rating Categories

The paper continues an equity valuation model based on a random process modelling of earnings and book value, coupled with rating categories and rating migration. In essence, earnings and book value probability distributions are related to rating categories, and the probability of an issue to have a certain rating category at a certain time is calculated. Based on this, earnings are forecast as probability distributions. As reflected by the output distributions, in general, given its premises, the valuation model more realistically models inherent uncertainty, particularly increased uncertainty with time. It is noted that this approach to equity valuation is rather similar to reduced form models used with bond valuation. As a consequence, the probability of default is naturally incorporated into the valuation model. The necessary input earnings per book value, and book value growth, probability distributions are simulated, in accordance with preceding research, and the resultant output earnings, and book value, probability distributions are calculated and outlined