Accounting for equity investments under IFRS 13: Are market multiple evaluations accurate?

Abstract

In capital markets, the investment decision-making process is vastly influenced by accounting information. This paper addresses equity investment valuation through market multiples and its consequences in investors’ financial statements under fair value accounting principles. After replicating the valuation process through the most used market multiples (price-to-forecasted earnings; market-to-book; enterprise-value-to-performance indicators), the authors analyze the distribution of the estimated-to-actual fair value ratio under the IFRS 13 perspective and the effects of a randomly selected portfolio on the balance sheet and income statement of the investor. The study’s primary findings are that the market multiples tend to produce consistent results in 7 (at least) to 20 (at best) out of 100 cases, and over or underestimate the fair value in all the remaining cases without any apparent or predictable reason. The results of the paper confirm what previous literature underlined by studies conducted on older data and with a different geographical scope (Kim & Ritter, 1999; Lie & Lie, 2002; Palea & Maino, 2013). The results and the literature suggest being particularly cautious in applying the market multiples valuation method for estimating the fair value of an equity investment, given the preference that accounting principles accord to the Level 2 market-comparable methods, which also seem to be the most used ones in practice