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.
Classic Paper: Company Valuation Methods August 14, 2006
We have selected for retrospective review a few all-time “best selling” research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the March 2004 update of the paper entitled “Company Valuation Methods: The Most Common Errors in Valuations” (download count over 6,000) by Pablo Fernandez. In this paper, the author describes the four most widely used company valuation methods: (1) balance sheet-based; (2) income statement-based; (3) goodwill-based; and, (4) cash flow discounting-based. He also illustrates a break-up value calculation and summarizes the valuation errors he has most commonly encountered. He states that: More…
Are the Returns for IBD’s New America Index for Real? July 27, 2006
A reader asked whether IBD’s New America Index, which IBD claims has trounced that of the S&P 500 index by over 160% since late 1998 is “for real.” There is little publicly available information on the New American Index. Using what we can find, we conclude that: More…
Earnings, Inflation and Stock Returns June 20, 2006
In their February 2003 paper entitled “Stock Returns, Aggregate Earnings Surprises, and Behavioral Finance”, Jonathan Lewellen, S. Kothari and Jerold Warner explore the relationships between overall stock market behavior and aggregate corporate earnings, looking for parallels with firm-level price-earnings behavior. Using quarterly data for 1970-2000, they conclude that: More…
Focus on Return on Investment, Not P/E May 16, 2006
Can one calculate what the return from the overall stock market, or from a specific stock, should be? In the never-ending quest to achieve this goal, Hollister Sykes presents his recent “An Equity Market Model and Its Implications”. This model calculates investor return as a function of four variables: (1) earnings yield; (2) return on equity; (3) ratio of dividend payout to earnings; and, (4) ratio of share repurchases or sales value to earnings. Model details and implications, and the results of testing it with 133 years of aggregate market data, are as follows: More…
Out-of-Sample Test for a Stock Market Model February 9, 2006
In their April 2002 paper entitled “Solving the Price-Earnings Puzzle” Carl Chiarella and Shenhuai Gao investigate the interrelationships of stock prices (the S&P 500 index), earnings and interest rates (the Federal Funds Rate) during January 1979 to August 2001. They conclude that the stock index is proportional to aggregate earnings and inversely proportional to the interest rate. Using data for these variables since January 1990, we find that: More…
Classic Research: Mean Reversion in Corporate Profitability January 12, 2006
We have selected for retrospective review a few all-time “best selling” research papers of the past few years from the General Financial Markets category of the Social Science Research Network (SSRN). Here we summarize the February 1999 paper entitled “Forecasting Profitability and Earnings” (download count over 3,600) by Eugene Fama and Kenneth French. Is corporate profitability mean reverting due to competitive forces, as entrepreneurs exit relatively unprofitable industries and enter relatively profitable industries. Are there therefore predictable patterns in corporate earnings? Using a simple return-on-assets model applied to an average of 2304 firms per year over the period 1964-1995, the authors conclude that: More…
Earnings Guidance Lags the Market? August 8, 2005
In the June 2005 update of their paper entitled “Is Guidance a Macro Factor? The Nature and Information Content of Aggregate Earnings Guidance”, Carol Anilowski, Mei Feng and Douglas Skinner investigate whether aggregate management earnings guidance predicts future aggregate earnings news and overall stock market returns. Using a sample of 31,320 annual and quarterly management earnings forecasts for 1994-2003 from Thomson First Call, they find that: More…
Pricing Corporate News May 31, 2005
In their May 2005 draft paper entitled “The Market Impact of Corporate News Stories”, Werner Antweiler and Murray Frank apply computational linguistics to 245,429 Wall Street Journal news stories published during 1973 to 2001 to examine how, and how quickly, stock prices fully reflect 43 different kinds of news. They find that: More…
Piotroski’s Efficient Value Investing October 13, 2004
In his January 2002 paper entitled “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers”, Joseph Piotroski applies a simple accounting-based fundamental analysis strategy to a broad portfolio of high (top 20%) book-to-market firms to enhance returns. His stock scoring system consists of nine binary signals based on profitability and value-specific financial measures (see the list below). Using data from the period 1976-1996, he finds that: More…
Is Irrational Exuberance Over Yet? October 11, 2004
In the early 2001 update of their 1998 paper entitled “Valuation Ratios and the Long-Run Stock Market Outlook: An Update”, John Campbell and Robert Shiller focus on mean reversion of two valuation ratios, price-earnings and dividend-price, as key predictors of future stock market performance. The authors determine that mean reversions of these ratios occurs through stock price changes, not earnings or dividend changes. At the time of the update, they note that “these ratios imply a stronger case for a poor stock market outlook than has ever been seen before.” More…
