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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.

Poor Firm Management and Stock Returns

Do negative environmental, social and governance (ESG) incidents (environmental pollution,
poor employment conditions or anti-competitive practices) indicate poor firm management and therefore underperforming stocks? In his February 2021 paper entitled “ESG Incidents and Shareholder Value”, Simon Glossner analyzes ESG incident data to determine whether: (1) history is predictive of future ESG incidents; (2) high incident rates impact firm performance: and, (3) the stock market prices incidents. Using over 80,000 incident news items, firm information and stock returns for 2,848 unique U.S. public firms starting January 2007 and a smaller sample for European firms starting January 2009, all through December 2017, he finds that: Keep Reading

Remaking Value Investing

Value investing performance over the past two decades is poor. Is this underperformance a temporary consequence of an unusual macro environment, or a reflection of permanent economic/equity market changes. In their February 2021 paper entitled “Value Investing: Requiem, Rebirth or Reincarnation?”, Bradford Cornell and Aswath Damodaran survey the history and alternative approaches to value investing, with focus on its failure in recent decades. They then discuss how value investing must adapt to recover. Based on the body of value investing research through 2020, they conclude that: Keep Reading

Valuation-based Stock Market Return Expectations

What performance should investors expect from the S&P 500 Index based on price-to-earnings (P/E) and Cyclically-Adjusted Price-to-Earnings (CAPE, or P/E10)? In their November 2020 paper entitled “Extreme Valuations and Future Returns of the S&P 500”, Shaun Rowles and Andrew Mitchell take a layered “regression upon a regression” approach to predict S&P 500 Index returns and level. First, to estimate future returns, they run a linear regression on P/E, P/E10, S&P 500 dividend yield, inflation, 10-year U.S. Treasury note yield, historical 1-year, 3-year, 5-year and 10-year S&P 500 Index returns and percentiles of many of these variables within their respective historical distributions. Then, they run separate linear regressions to predict 1-year, 3-year, 5-year and 10-year future annualized returns. Finally, they run a linear regression to model current S&P 500 Index level for comparison to actual current level. Using Robert Shiller’s U.S. stock market and economic data spanning January 1871 through June 2020, they find that: Keep Reading

Intangible Value Factor

Intangible assets derive largely from investments in employees, brand and knowledge that are expensed rather than booked. Despite large and growing importance of intangible assets, traditional measures of firm value ignore them. Are firm value assessments therefore defective? In their October 2020 paper entitled “Intangible Value”, Andrea Eisfeldt, Edward Kim and Dimitris Papanikolaou evaluate a value factor that includes intangible assets in book equity for each firm (HMLINT) following exactly the methodology used to construct the widely accepted Fama-French value factor (HMLFF). They measure intangible assets based on flows of Selling, General, and Administrative (SG&A) expenses. Using firm accounting data and associated monthly stock returns and Fama-French 5-factor model data for a broad sample of U.S. stocks during January 1975 through December 2018, they find that:

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Timing GBTC Based on Its Inferred Premium

“Evolution of Bitcoin as an Investment” suggests a shift toward acceptance of Bitcoin (BTC) as an investment asset, as do recent actions by some large investors. Grayscale Bitcoin Trust (GBTC) offers a way for investors to access BTC via a fund that manages BTC holdings. GBTC price generally carries a premium over its BTC holdings in consideration for this convenience (17% as of the end of 2020). Does variation in this premium indicate good times to buy and sell GBTC? To investigate, we use the ratio GBTC/BTC (with BTC divided by 1,000 because the prices greatly differ in scale) as an easy way to infer the premium. We then look at ways to exploit variation in the ratio to buy and sell GBTC. Because of the rapid evolution of Bitcoin, we limit analysis to recent data. Using daily closing prices of GBTC and BTC during 2019 through 2020, we find that: Keep Reading

CAPE (P/E10) Version of Fed Model?

How does the Cyclically Adjusted Price-to-Earnings ratio (CAPE, or P/E10) behave during the COVID-19 pandemic? What are its current implications? In the November 2020 revision of their paper entitled “CAPE and the COVID-19 Pandemic Effect”, Robert Shiller, Laurence Black and Farouk Jivraj examine behavior of CAPE during 2020 in the U.S., UK, Europe, Japan and China, highlighting the impact of the pandemic. They apply CAPE to generate current 2-year, 5-year and 10-year equity return forecasts based on full-sample regressions. They then extend the CAPE forecasting approach to forecast changes in excess real return of stocks over bonds (see the chart below) to explore why investors strongly prefer equities over bonds during the pandemic. Finally, they look at sector dynamics within each economy. Using Shiller data during January 1871 through September 2020, they find that: Keep Reading

S&P 500 Index Additions Underperform?

Do stocks added to major indexes, such as the S&P 500 Index, exhibit exceptionally strong subsequent returns? In their July 2020 paper entitled “Does Joining the S&P 500 Index Hurt Firms?”, Benjamin Bennett, René Stulz and Zexi Wang investigate effects on firms/stocks of joining the S&P 500 Index and whether these effects change over time. They estimate abnormal stock performance using both market-adjusted returns and alphas from 3-factor (market, size, book-to-market), 4-factor (adding momentum) or 5-factor (adding profitability and investment instead of momentum) models of stock returns. Using monthly and daily fundamentals and price data for 659  firms/stocks added to the S&P 500 Index during 1997 through 2017, they find that:

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FactSet S&P 500 Earnings Growth Estimate Evolutions

A subscriber, citing the weekly record of S&P 500 earnings growth estimates in the “FactSet Earnings Insight” historical series, wondered whether estimate trends/revisions are exploitable. To investigate, we collect S&P 500 quarterly year-over-year earnings growth estimates as recorded in this series. These data are bottom-up (firm by firm) aggregates, whether purely from analyst estimates (before any actual earnings releases), or a blend of actual earnings and estimates (during the relevant earnings season). Using these data and contemporaneous weekly levels of the S&P 500 Index during April 2011 through June 2020, we find that: Keep Reading

COVID-19 Impacts on Stock Valuation

What are the roles of changes in earnings forecasts and the discount rate on stock valuation during the COVID-19 stock market crash? In the May 2020 update of their paper entitled “Earnings Expectations in the COVID Crisis”, Augustin Landier and David Thesmar investigate firm-level analyst earnings forecast revisions and discount rate changes as jointly reflected in stock market behavior during COVID-19 discovery and spread. They further decompose the effect of discount rate changes into impacts of: (1) change in interest rates, (2) change in equity risk premium and (3) the leverage effect (declining stock prices driving an increase in expected equity return). Using analyst earnings forecasts and prices for the top 1000 U.S. stocks by market capitalization as of year-end 2019, and contemporaneous interest rates, during January 2020 through mid-May 2020, they find that:

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Impact of COVID-19 on Markets and Economies

Economic data arrive too slowly to help investors navigate crises such as the 2019 coronavirus (COVID-19) outbreak. Are there data that support quick reactions? In their March 2020 paper entitled “Coronavirus: Impact on Stock Prices and Growth Expectations”, Niels Gormsen and Ralph Koijen employ equity index dividend futures by maturity to understand the evolution of investor reactions to COVID-19 outbreak and subsequent policy actions. They argue that a stock market decline means that expected future dividends fall and/or the discount rate for future dividends rises, differently by maturity. These changes in expectations affect stock market valuation. Using daily dividend futures closing mid-quotes in the U.S. and settlement prices in the EU during January 2006 through March 25, 2020, they find that:

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