Authors: Apostolos Ballas, Efthimios Demirakos

Title: THE VALUATION PROPERTIES OF THE RATING TO ECONOMIC PROFIT

Abstract

Drawing upon valuation theory and the empirical evidence of a strong positive association between the price-to-book and return on equity, HSBC’s financial analysts construct an intuitive and readily understandable fundamentals-based investment criterion, called Rating to Economic Profit (REP). While variations of this model are used in practice by financial analysts, the academic community has mostly ignored REP. In this study, we justify its use as an investment appraisal technique, provide some extensions of the basic formula, and discuss implementation issues. We also offer some illustrative examples from equity research reports, which may serve as insightful cases facilitating the work of valuation educators and practitioners.