Fundamental Valuation

What fundamental measures of business success best indicate the value of individual stocks and the aggregate stock market? How can investors apply these measures to estimate valuations and identify misvaluations? These blog entries address valuation based on accounting fundamentals, including the conventional value premium.

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Professional Equity Valuation Methods

How do those whose jobs involve stock valuation perform this task? In their September 2015 paper entitled “Equity Valuation: A Survey of Professional Practice”, Jerald Pinto, Thomas Robinson and John Stowe report results of a 38-question equity valuation practices survey sent to 13,500 CFA Institute members with equity analysis job responsibilities. They guided respondents through the survey via the following introductory question:

“In evaluating individual equity securities, which of the following approaches to valuation do you use? (Select all that apply)

a) A market multiples approach (e.g., based on price-to-earnings, enterprise value-to-EBITDA, or other multiples)
b) A present discounted value approach (e.g., based on forecasts of future dividends, free cash flows, or economic value added/residual income)―also known as the income approach
c) An asset-based approach (e.g., based on book value, adjusted book value, asset market values, or asset replacement costs)
d) A (real) options approach (using options models to value equity)
e) Other (please specify)”

Using responses from 1,980 completed questionnaires, they find that: Keep Reading

Value Strategy Update

We have updated the the monthly asset class ETF value strategy weights and associated performance data at Value Strategy.

Momentum Strategy and Trading Calendar Updates

We have updated the the monthly asset class ETF momentum winners and associated performance data at Momentum Strategy.

We have updated the Trading Calendar to incorporate data for September 2015.

Technical vs. Fundamental Investment Recommendations

Are expert technicians or fundamentalists better forecasters of short-term and intermediate-term asset returns? In the August 2015 version of their paper entitled “Talking Numbers: Technical versus Fundamental Recommendations”, Doron Avramov, Guy Kaplanski and Haim Levy assess the economic value of dual technical and fundamental recommendations presented simultaneously on “Talking Numbers”, a CNBC and Yahoo joint broadcast… “featuring fundamental and technical recommendations before and during the market open. Dual recommendations are made by highly experienced analysts representing prominent institutions.” Recommendations address both individual stocks and asset classes, including U.S. and foreign broad equity indexes, sector/industry equity indexes, bonds, commodities and exchange rates. Using 1,000 dual recommendations on 262 stocks and 620 dual recommendations on other assets, along with associated price data, during November 2011 through December 2014, they find that: Keep Reading

Stock Market Valuation Ratio Trends

To determine whether the stock market is expensive or cheap, some experts use aggregate valuation ratios, either trailing or forward-looking, such as earnings-price ratio (E/P) and dividend yield. Operating under a belief that such ratios are mean-reverting, most imminently due to movement of stock prices, these experts expect high (low) future stock market returns when these ratios are high (low). Where are the ratios now? Using the most recent actual and forecasted earnings and dividend data from Standard & Poor’s, we find that: Keep Reading

P/E10s Worldwide in 2015

What are current implications of cyclically adjusted price-earnings ratios (CAPE, P/E10 or Shiller PE), stock index level divided by average real earnings over the past ten years, across country equity markets worldwide? In his July 2015 paper entitled “CAPE around the World: Update 2015 – Return Differences and Exchange Rate Movements”, Joachim Klement analyzes expected returns in local currencies for equity markets around the world based on an adjusted P/E10. His adjustment accounts for economic conditions in each country via regression of local P/E10 versus real GDP growth, real per capita GDP growth, real interest rate and inflation. He also examines interactions among exchange rate movements, adjusted P/E10s and expected returns. Using stock index level, P/E10, economic data and exchange rate versus the U.S. dollar for 20 developed and 18 emerging equity markets as available through June 2015, he finds that: Keep Reading

Combining Annual Fundamental and Monthly Trend Screens

Stock return anomaly studies based on firm accounting variables generally employ annually reformed portfolios that are long (short) the tenth of stocks expected to perform well (poorly). Does adding monthly portfolio updates based on technical stock price trend measurements boost anomaly portfolio performance? In the June 2015 version of their paper entitled “Anomalies Enhanced: The Use of Higher Frequency Information”, Yufeng Han, Dayong Huang and Guofu Zhou test eight equal-weighted long-short portfolios that combine annual screening based on a predictive accounting variable with monthly screening based on a simple moving average (SMA)-based stock price trend rule. The eight accounting variables (screened in June based on prior December data) are: (1) book-to-market ratio; (2) gross profitability; (3) operating profitability; (4) asset growth; (5) investment growth; (6) net stock issuance; (7) accruals; and, (8) net operating assets. The price trend screen excludes from the long (short) side of the portfolio any stock for which 50-day SMA is less than (greater than) 200-day SMA at the end of the prior month. Using accounting and daily price data for a broad sample of U.S. stocks during July 1965 through December 2013, they find that: Keep Reading

Tilting or Indexing, Fundamentally?

Are there gradual steps toward a fundamental stock index that work just as well? In their April 2015 draft paper entitled “Decomposing Fundamental Indexation”, Gregg Fisher, Ronnie Shah and Sheridan Titman compare fundamental indexing strategies to strategies that tilt a market index toward high fundamental-to-price stocks. Fundamental indexing strategies weight stocks by firm fundamentals instead of market capitalizations, ignoring any information in stock prices. The tilt strategies adjust market weights with multipliers linearly scaled to fundamental-to-price ratios across a universe of stocks. Reflecting extreme fundamentals ratios for smaller stocks, the range of multipliers for stocks in the upper (lower) half of market capitalizations is 0 to 2 (0 to 4). After applying multipliers, tilt the strategies normalize weights so that they sum to 100%. Rebalancing for all portfolios is annual on the last day in April, incorporating a minimum four-month lag between the end of the financial reporting period and portfolio formation. Using data for a broad sample of U.S. common stocks during May 1975 through December 2014, they find that: Keep Reading

Tactical U.S. Stock Market Allocations Based on Valuation Ratios

Do simple stock market valuation ratios work for tactical allocation? In his April 2015 paper entitled “Multiples, Forecasting, and Asset Allocation”, Javier Estrada investigates whether investors can outperform a 60-40 stocks-bonds benchmark portfolio via tactical strategies based on one of three simple stock market valuation ratios: (1) dividend-price ratio (D/P); (2) price-earnings ratio (P/E); or, (3) cyclically adjusted price-earnings ratio (CAPE, or P/E10). The valuation‐based strategies take aggressive (conservative) stances when stocks are cheap (expensive) via combinations of the following rules:

  • Designate stocks as cheap (expensive) when a valuation ratio is below (above) its inception-to-date mean by one standard deviation (1SD) or two standard deviations (2SD).
  • Use 60-40 stocks-bonds allocations when stocks are not cheap or expensive. When stocks are cheap (expensive), shift toward stocks (bonds) by 20% to 80-20 (40-60) or by 30% to 90-10 (30-70). 
  • Rebalance either annually or monthly.

For the benchmark portfolio and the valuation-based portfolios when in 60-40 stance, rebalancing occurs only when the stock allocation drifts below 55% or above 65%. To accrue at least 20 years of data for initial valuations, strategy performance measurements span 1920 through 2014 (95 years). Calculations lag dividends and earnings by three months to ensure real-time availability. Testing ignores trading frictions and tax implications. Using monthly S&P 500 Index total returns and the yield on 90-day U.S. Treasury bills (T-bills) during September 1899 through December 2014, he finds that: Keep Reading

Cash Flow Part of Profitability as a Stock Return Predictor

Is the part of profitability based on cash flow more informative than the part based on accruals? In their March 2015 paper entitled “Accruals, Cash Flows, and Operating Profitability in the Cross Section of Stock Returns”, Ray Ball, Joseph Gerakos, Juhani Linnainmaa and Valeri Nikolaev investigate the power of the cash flow part of profitability to predict stock returns. They compare its predictive power to those of overall operating profitability and of the accruals part of profitability. Using monthly returns and annual firm accounting data (lagged six months) for a broad sample of U.S. common stocks during July 1963 through December 2013, they find that: Keep Reading

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Current Momentum Winners

ETF Momentum Signal
for October 2015 (Final)

Winner ETF

Second Place ETF

Third Place ETF

Gross Compound Annual Growth Rates
(Since August 2006)
Top 1 ETF Top 2 ETFs
12.3% 12.6%
Top 3 ETFs SPY
12.7% 6.5%
Strategy Overview
Current Value Allocations

ETF Value Signal
for October 2015 (Final)





The asset with the highest allocation is the holding of the Best Value strategy.
Gross Compound Annual Growth Rates
(Since September 2002)
Best Value Weighted 60-40
12.1% 9.6% 7.6%
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