Since 2002 when the SEC passed NASD Rule 2711, analysts in the U.S. have been required to state their valuation method in the text of their research reports. The current statute is FINRA Rule 2241, which says “any recommendation, rating, or price target [must be] accompanied by a clear explanation of any valuation method used.”
The chapter 2 webpage reported on a study that found that most analysts use a trailing P/E (price-to-earnings) to get to an estimated price: They multiply their earnings forecast by the trailing P/E, sometimes with adjustments, sometimes based on the firm’s own past P/E, sometimes based on the P/E of comparable firms. The study found that trailing twelve-month P/E ratios account for 91% of the variation in analysts’ price targets.
Chapter 2 warned against such a practice. It assumes the price in the trailing P/E is an efficient price and thus a basis for a fundamental valuation. And, as chapter 2 explained, P/E is based on both growth and risk, so the practice assumes that expected earnings growth and risk remain unchanged from the trailing year. The method has obvious difficulties when either the trailing or forward earnings are negative. (Analysts sometimes use EBITDA to get to a positive number in this case, also suspect.)