Real Options in the Brazilian Power Generation Sector: Are Domestic Equity Research Analysts Blind-Sighted or Is It Just a Temporary Glitch?

The Real Options theory (“ROT”) states firms should be approached as a combination of real assets and real options. Domestic equity research analysts do not seem to evaluate companies applying ROT. After reviewing 344 (from a total estimated 368) equity research reports or analyses on Brazilian listed power generation companies produced between December 31, 2020, and April 30, 2021, we find only discounted cash flow (“DCF”) techniques are applied. No single mention to ROT is made. To estimate the magnitude of potential misvaluations, we use the Black-Scholes method to price the growth plans made publicly available by each of those 15 companies in that period and compare the outcome with the analysts’ forecasted equity value upside per company. Our results suggest local analysts have ignored a sizeable intrinsic value to those companies by failing to apply ROT. Potential explanations range from behavioral biases to low power sector representativeness at IBOVESPA.