DOCSLIB.ORG

Where's the Value in Value?

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Where's the Value in Value? AC T I V E M A N AG E ME N T Where’s the Value in Value? MARCH 2016 Based on style indices, value investing has been cold as ice, growth has seen its hottest streak since the 1990s tech bubble and value exposure has recently hurt relative performance for many diversified portfolios. Why has growth been so dominant? Is there any value left in value? We asked the experts. Six CBIS equity sub-advisers offer their perspectives on the value/ growth divide. One of the most prominent equity market trends of the past few years is the dominance of growth-style returns over those of value. The Russell 1000 Growth Index outgained the Summary Russell 1000 Value Index by more than 900 basis points in 2015. Growth’s outperformance CBIS asked six of our active equity extends, albeit to a lesser degree, over the trailing five-year period. What’s driving the trend? sub-advisers to offer their thoughts on value’s recent weakness and What conclusions should investors draw from it? growth’s dominance. Their insights include informed perspectives on We asked the experts. Six CBIS equity sub-advisers offer their take on value’s slump and market cycles, relative valuation, what it might mean for markets and portfolios from here. Read on to see why headline style global central banking and implica- tions for portfolio strategy in 2016. indices don’t tell the whole story and why the outlook for value investors is brighter than it might seem. AJO CUIT Value Equity Quant value-specialist AJO shows how sector returns have dominated growth and value Causeway Capital Management index performance; when adjusted for sector influence, value has actually performed well. CUIT International Equity Causeway Capital Management shows that investors are paying a substantial premium for Los Angeles Capital Management defensiveness and momentum characteristics and that value and cyclical stocks are among CUIT Growth Equity the market’s best bargains. The quants at Los Angeles Capital Management make clear there’s Principal Global Investors more to value and growth than headline numbers; value factor construction makes a big CUIT International Equity difference in assessing value’s performance. International sub-adviser Principal Global Inves- Scott Investment Partners tors also ties value’s slump to sector influences and explains why they apply a balanced UCITS Global Equity growth/value discipline within their CBIS growth mandate. Scott Investment Partners shows Wellington Management Company how years of global central bank easy money policies have badly distorted market valuations CUIT Growth Equity and the traditional concepts of growth and value. Growth sub-adviser Wellington Manage- ment Company digs deep into the growth universe and shows how attractively valued growth names have lagged more expensive peers; a shift in this “cycle within a cycle” could become a tailwind for valuation-conscious growth portfolios. Page 1 Value vs. Growth MARCH 2016 AJO 1: R1000 Value vs. R1000 Growth AJO 2: Growth Cycle Duration 0.5 1.0 value outperforms Post tech bubble 0.8 0.3 0.5 The 80's 0.3 0.0 0.0 (0.3) (0.3) Indexed Return (0.5) Post GFC (0.8) growth outperforms Tech bubble (1.0) (0.5) 1 10192837465564738291100 79 82 85 88 91 94 97 00 03 06 09 12 15 Months Source: AJO / Note: Log index of cumulative relative return; Jan 1979 - Feb. 2016 Source: AJO AJO 3: Price/Earnings — Sector Adjusted Cumulative Return result is a polarized group of stocks and sectors in the Russell 1000 Value Index based on a composite measure of cheapness. 40.0% In fact, the most recent period of value underperformance has 30.0% been driven largely by sector allocation. On an annualized basis, 20.0% the growth index outperformed the value index by 4% — and, interestingly, nearly 75% of this return differential is a result of 10.0% growth sectors outperforming value sectors. For example, 0.0% growth typically dominates when information technology out- 07 08 09 10 11 12 13 14 15 -10.0% performs financials and consumer stocks outperform energy. As such, the financial crisis and oil shocks define this period far Source: AJO more than a breakdown in the fundamentals of value investing. Whew! AJO Let’s just get this out there — we’re value investors. And yes, we Prior to this period, the impact of sector allocation between the realize that growth stocks outperformed value stocks over the style benchmarks went the other way, adding to the returns of last — let’s say — nine years. In fact, as shown in Charts 1 and 2, the value index. Regardless of direction, the influence of sectors we are experiencing the longest had previously only accounted for growth market (when defined by about 10% of the difference in returns “It is clear that style performance has lately the Russell 1000 Growth Index — not the 75% we noted above. been defined by sector performance. And outperforming the Russell 1000 while comparing index returns is still a But how does value perform if we Value Index) since the Russell style valid definition of style, recognizing value neutralize this sector impact? At AJO, indexes were created. The last as a determinant of stock selection tells a we assess value using a number of growth-dominated market (the different tale.” measures; one of our favorites is price 1990s tech bubble) proved that -AJO relative to forecasted earnings. To value stocks can underperform for evaluate this impact, we use this a long time and inflict plenty of measure of value to simulate an equal-weighted portfolio com- pain on value investors. But the current regime is winning on prising long exposure to the least expensive stocks within each endurance alone. Do these index results spell the end of value sector and shorting the most expensive. As shown in Chart III, it investing as we know it? Hardly! turns out we would have performed quite well if we selected It’s probably useful to review how these benchmarks are created. stocks on this measure. In a costless world, the cumulative re- Once a year, Russell evaluates securities across each capitaliza- turn of this strategy is 35% (think of it as alpha) over the nearly tion universe using three measures: price to book, earnings nine-year period, without taking on any market risk. Not too growth and sales growth. Each security is categorized as 100% shabby. value, 100% growth or some combination of each. The end Christian Brothers Investment Services, Inc. [email protected] Page 2 Value vs. Growth MARCH 2016 It is clear that style performance has lately been defined by sec- Causeway 1: Value Cycles — Cumulative Return & Drawdowns tor performance. And while comparing index returns is still a valid definition of style, recognizing value as a determinant of 0.0% 1.7 stock selection tells a different tale. The fundamental quest to -2.0% 1.6 find stocks with the most attractive valuations relative to peers -4.0% 1.5 is still our most effective tool. As Mark Twain might say (with -6.0% 1.4 some liberties): “The reports of value’s death have been greatly -8.0% 1.3 exaggerated.” -10.0% 1.2 Drawdown Depth Depth (%) Drawdown -12.0% 1.1 Causeway Capital Management Cumulative Return Index Unimpeded, stock markets will eventually correctly price the -14.0% 1.0 91 95 97 01 05 07 11 15 fundamentals of a business; this is the cornerstone of value in- - - - - - - - - Jan-93 Jan Jan Jan-99 Jan Jan-03 Jan Jan Jan-09 Jan Jan-13 Jan Jan vesting. But there’s no question that investor sentiment moves Drawdown Cumulative (RHS) in cycles and value investing is deeply out of favor. As shown Source: Causeway Capital Management / Note: Value performance based on proprietary risk model’s value factor return. in Chart 1, value’s recent weakness even rivals what occurred during the late 1990s technology, media and telecommunica- Causeway 2: High Premiums for Momentum and Defensiveness tions bubble. As shown in Chart 2, investors are paying a sub- stantial premium for defensiveness and price momentum; stocks 100% featuring these characteristics are quite expensive versus other 80% segments of the markets (and even within industries), with 60% multiples well above long-term averages. 40% The conundrum facing beleaguered value managers and their 20% clients is that value-oriented and high-beta cyclical stocks are 0% among the best bargains in global equity markets, especially in -20% emerging markets. And despite what our emotions tell us, buy- -40% Momentum Premium ing well-chosen, out-of-favor stocks generally decreases rather Defensive Premium -60% than elevates the risk of future losses. But what will spur inves- tors in general to again appreciate the value in value? Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 An easing of deflation concerns should encourage investors to Source: Causeway Capital Management / Note: Valuation difference between top and bottom quintiles based on Causeway analytics. return to value investing rather than crowd further into the mo- strengthening currency since 2011. But with the U.S. dollar giv- mentum and growth trade. To be sure, anemic global economic ing up ground this year, depreciating versus the euro and yen, growth in many areas outside the U.S. has partly caused the downward pressure on commodity preference for defensive companies. prices should abate and prospects for But global growth should remain “The conundrum facing beleaguered value related industries should improve. The positive and, following steep de- managers and their clients is that value- Fed’s stated concern about the global clines, the risk/reward balance for oriented and high-beta cyclical stocks are effects of dollar appreciation could be companies tied to the economic and among the best bargains in global equity another factor that stalls or reverses commodity cycle swings in favor of markets.” the strong dollar/weak commodity reward.
Load more

Recommended publications
  • Portfolio Construction + Management with Factset
    www.factset.com Truly Active Management Requires a Commitment to Excellence: PORTFOLIO CONSTRUCTION + MANAGEMENT WITH FACTSET Bijan Beheshti, John Guerard, and Chris Mercs Truly Active Management Requires a Commitment to Excellence: Portfolio Construction and Management with FactSet1 Bijan Beheshti FactSet Research Systems Inc. San Francisco, CA John Guerard McKinley Capital Management, LLC Anchorage, AK 99503 ([email protected]) and Chris Mercs FactSet Research Systems Inc. San Francisco, CA February 2020 This paper is forthcoming in John Guerard and William T. Ziemba, Editors, Handbook of Applied Investment Research (Singapore: World Scientific Publishing, 2020). 1 The authors thank Ross Sharp, formerly of FactSet, who created the R-robust regression script. Truly Active Management Requires a Commitment to Excellence: Portfolio Construction and Management with FactSet Financial anomalies have been studied in the U.S. and recent evidence suggests that they have diminished in the U.S. and possibly in non-U.S. portfolios. Have the anomalies changed and are they persistent? Have historical and earnings forecasting data been a consistent and highly statistically significant source of excess returns? We test many financial anomalies of the 1980s-1990s and report that several models and strategies continue to produce statistically significant excess returns. We also test a large set of U.S. and global variables over the past 16 years and report that many of these fundamental, earnings forecasts, revisions, breadth and momentum, and cash deployment strategies maintained their statistical significance during the 2003-2018 time period. Moreover, the earnings forecasting model and robust regression estimated composite model excess returns are greater in Non-U.S.
    [Show full text]
  • Equity-Bond Yield Correlation and the FED Model: Evidence of Switching Behaviour from the G7 Markets
    This is a post-peer-review, pre-copyedit version of an article published in Journal of Asset Management. The final authenticated version is available online at: https://doi.org/10.1057/s41260- 018-0091-x Equity-Bond Yield Correlation and the FED Model: Evidence of Switching Behaviour from the G7 Markets February 2018 Revised April 2018 This Version June 2018 Abstract This paper considers how the strength and nature of the relation between the equity and bond yield varies with the level of the real bond yield. We demonstrate that at low levels of the real bond yield, the correlation between the equity and bond yields turns negative. This arises as the lower bond yield implies heightened macroeconomic risk (e.g., deflation and economic stagnation) and causes equity and bond prices to move in opposite directions. The FED model relies on a positive relation for its success in predicting future returns. Thus, we argue that the mixed empirical evidence regarding the FED model arises due to this switch in correlation behaviour. We present supportive evidence for the switching relation and its link to the level of the bond yield using linear and non-linear smooth transition panel regression techniques for the G7 markets. The results presented here should be of interest to market practitioners who may wish to use the FED model to aid market timing decisions and for academics interested in understanding the interrelations between markets. Keywords: Equity Returns, Bond Returns, Correlation, Bond Yield, Switching JEL: C22, C23, E44, G12, G15 1 1. Introduction. The FED model implies a positive relation between the equity and bond yields.
    [Show full text]
  • The Predictive Ability of the Bond-Stock Earnings Yield Differential Model
    The Predictive Ability of the Bond-Stock Earnings Yield Differential Model KLAUS BERGE,GIORGIO CONSIGLI, AND WILLIAM T. ZIEMBA FORMAT ANY IN KLAUS BERGE he Federal Reserve (Fed) model prices and stock indices has been studied by is a financial controller provides a framework for discussing Campbell [1987, 1990, 1993]; Campbell and for Allianz SE in Munich, stock market over- and undervalu- Shiller [1988]; Campbell and Yogo [2006]; Germany. [email protected] ation. It was introduced by market Fama and French [1988a, 1989]; Goetzmann Tpractitioners after Alan Greenspan’s speech on and Ibbotson [2006]; Jacobs and Levy [1988]; GIORGIO CONSIGLI the market’s irrational exuberance in ARTICLELakonishok, Schleifer, and Vishny [1994]; Polk, is an associate professor in November 1996 as an attempt to understand Thompson, and Vuolteenaho [2006], and the Department of Mathe- and predict variations in the equity risk pre- Ziemba and Schwartz [1991, 2000]. matics, Statistics, and Com- mium (ERP). The model relates the yield on The Fed model has been successful in puter Science at the THIS University of Bergamo stocks (measured by the ratio of earnings to predicting market turns, but in spite of its in Bergamo, Italy. stock prices) to the yield on nominal Treasury empirical success and simplicity, the model has [email protected] bonds. The theory behind the Fed model is been criticized. First, it does not consider the that an optimal asset allocation between stocks role played by time-varying risk premiums in WILLIAM T. Z IEMBA and bonds is related to their relative yields and the portfolio selection process, yet it does con- is Alumni Professor of Financial Modeling and when the bond yield is too high, a market sider a risk-free government interest rate as the Stochastic Optimization, adjustment is needed resulting in a shift out of discount factor of future earnings.
    [Show full text]
  • Thinking Differently About Dividends Dividendspersp 4/25/03 1:40 PM Page 3
    DividendsPersp 4/25/03 1:40 PM Page 1 Perspectives Thinking Differently About Dividends DividendsPersp 4/25/03 1:40 PM Page 3 Thinking Differently About Dividends Many senior executives view dividends as a low priority on the strategic agenda. They’re wrong. The unique set of circumstances that made dividends unfashionable during the long bull market of the 1980s and 1990s is fast disappearing. In the current economic envi- ronment, dividends are an especially impor- tant lever for generating above-average shareholder returns. That’s not to say that every company should increase its dividend yield—or even pay divi- dends at all. But every company should revisit its dividend policy. Doing so can greatly improve the strategy debate among a com- pany’s senior managers—whether they ulti- mately decide to increase the company’s dividend or not. Why Dividends Are Back in Fashion In the recent bull market, the practice of returning cash to investors through divi- dends was easy to dismiss. One familiar disin- centive was the double taxation of dividends according to U.S. tax law. Another was the fact that as executives were compensated increas- ingly through stock options, they were better off using excess cash to repurchase shares DividendsPersp 4/25/03 1:40 PM Page 4 (thus raising the value of options) rather than returning that cash to investors through dividends. Trends in the financial markets also dis- couraged dividends. With average total share- holder return (TSR) running in the high teens, a dividend yield of even 3 or 4 percent was a relatively minor contributor to achieving above-average TSR.
    [Show full text]
  • Earnings Yield As a Predictor of Return on Assets, Return on Equity, Economic Value Added and the Equity Multiplier
    Modern Economy, 2017, 8, 10-24 http://www.scirp.org/journal/me ISSN Online: 2152-7261 ISSN Print: 2152-7245 Earnings Yield as a Predictor of Return on Assets, Return on Equity, Economic Value Added and the Equity Multiplier Rebecca Abraham, Judith Harris, Joel Auerbach Huizenga College of Business, Nova Southeastern University, Fort Lauderdale, Florida, USA How to cite this paper: Abraham, R., Abstract Harris, J. and Auerbach, J. (2017) Earnings Yield as a Predictor of Return on Assets, This study identifies earnings yield as a measure of financial performance that Return on Equity, Economic Value Added is based on a firm’s ability to sell profitable goods. It excludes the irrationality and the Equity Multiplier. Modern Econo- that can confound market-based measures of financial performance by em- my, 8, 10-24. http://dx.doi.org/10.4236/me.2017.81002 phasizing a firm’s ability to earn profits as the indicator of superior perfor- mance. For the full sample, the differential effects of earnings yield on return Received: December 5, 2016 on assets, return on equity, stock returns, economic value added and the eq- Accepted: January 6, 2017 uity multiplier are determined for firms of different size and volatility. The Published: January 9, 2017 analysis is conducted both across industries and within the oil and gas, com- Copyright © 2017 by authors and puter software, biotechnology and retail industries. For the full sample of Scientific Research Publishing Inc. NASDAQ stocks from 2010-2014, earnings yield significantly explained re- This work is licensed under the Creative turn on assets, return on equity, stock returns, economic value added and the Commons Attribution International License (CC BY 4.0).
    [Show full text]
  • Inflation and the Stock Market: Understanding the “Fed Model”∗
    Inflation and the Stock Market: Understanding the “Fed Model”∗ Geert Bekaert† Columbia University and NBER Eric Engstrom‡ Federal Reserve Board of Governors This Draft: September 2008 JEL Classifications G12, G15, E44 Keyphrases Money illusion, Equity premium, Countercyclical risk aversion, Fed model, Inflation, Economic Uncertainty Dividend yield, Stock-Bond Correlation, Bond Yield Abstract: The so-called Fed model postulates that the dividend or earnings yield on stocks should equal the yield on nominal Treasury bonds, or at least that the two should be highly correlated. In US data there is indeed a strikingly high time series correlation between the yield on nominal bonds and the dividend yield on equities. This positive correlation is often attributed to the fact that both bond and equity yields comove strongly and positively with expected inflation. While inflation comoves with nominal bond yields for well-known reasons, the positive correlation between expected inflation and equity yields has long puzzled economists. We show that the effect is consistent with modern asset pricing theory incorporating uncertainty about real growth prospects and also habit-based risk aversion. In the US, high expected inflation has tended to coincide with periods of heightened uncertainty about real economic growth and unusually high risk aversion, both of which rationally raise equity yields. Our findings suggest that countries with a high incidence of stagflationshouldhaverelatively high correlations between bond yields and equity yields and we confirm that this is true in a panel of international data. ∗This work does not necessarily reflect the views of the Federal Reserve System or its staff. In particular, our use of the term "Fed Model" reflects only conventional parlance among finance practicioners for this common valuation model.
    [Show full text]
  • How to Know What Rate of Return to Expect from Your Stocks: Part 1
    How to Know What Rate of Return to Expect from your Stocks: Part 1 Introduction We believe there are two critical attributes that the prudent investor should consider before investing in a company (stock). Furthermore, these same two attributes can be used to calculate a reasonable expectation of the future return the stock is capable of generating on their behalf. These two attributes are valuation and the rate of change of earnings growth. Valuation indicates whether or not the company’s current earnings power compensates you for the risk you take, while the company’s future rate of change of earnings growth will be the driver of future returns. We believe these are very important concepts for prudent investors to understand for several reasons. First of all, you can make an investment at fair value into a low or slow growth company, and still not generate a high rate of return. On the other hand, the risk associated with achieving it is normally low. This is simply because achieving a low rate of earnings growth is easier to do. Conversely, you could overpay, perhaps even significantly so, for a very powerful or fast grower and still make a high rate of return, because of the power of compounding. However, by overpaying you are taking on more risk than you should for two reasons. First of all, the probability of a company achieving a very high rate of growth is very low, and second, longer term it’s virtually a given that price will return to fair value. Therefore, the investor will not be able to harvest the full measure of the company’s growth achievement.
    [Show full text]
  • Determinants of the Price - Earnings Ratio of Industrial Stocks, 1962-1966
    Louisiana State University LSU Digital Commons LSU Historical Dissertations and Theses Graduate School 1968 Determinants of the Price - Earnings Ratio of Industrial Stocks, 1962-1966. Hite Bennett Louisiana State University and Agricultural & Mechanical College Follow this and additional works at: https://digitalcommons.lsu.edu/gradschool_disstheses Recommended Citation Bennett, Hite, "Determinants of the Price - Earnings Ratio of Industrial Stocks, 1962-1966." (1968). LSU Historical Dissertations and Theses. 1377. https://digitalcommons.lsu.edu/gradschool_disstheses/1377 This Dissertation is brought to you for free and open access by the Graduate School at LSU Digital Commons. It has been accepted for inclusion in LSU Historical Dissertations and Theses by an authorized administrator of LSU Digital Commons. For more information, please contact [email protected]. This dSeeertatton has hew microfilmed exactly ** received 68-10,719 BENNETT, Hite, 1926- DETERMINANTS OF THE PRICE-EARNINGS RATIO OF INDUSTRIAL STOCKS, 1962-1966. Louisiana State University and Agricultural and Mechanical College, Ph. D., 1968 Economics, finance University Microfilms, Inc., Ann Arbor, Michigan DETERMINANTS OF THE PRICE-EARNINGS RATIO OF INDUSTRIAL STOCKS, 1962-1966 A Dissertation Submitted to the Graduate Faculty of the Louisiana State University and Agricultural, and M echanical College in partial fulfillment of the requirements for the degree of Doctor of Philosophy in The Department of Business Finance and Statistics by Hite Bennett B.S., Texas A. & M. University, 1949 M .B.A., Louisiana State University, 1966 January, 1968 ACKNOWLEDGEMENT The writer is indebted to Professor Donald E. Vaughn, Chairman of his Supervisory Committee, for guidance throughout this research. Appreciation is extended to Professors P. P. Boyer, Roger L.
    [Show full text]
  • Factor Exposure Indexes Value Factor
    Research Factor exposure indexes Value factor ftserussell.com August 2014 1. Summary The value effect is one of the most studied market anomalies [2-5]. The value effect or value premium refers to the tendency of stocks with lower valuation ratios to earn above average returns over the long run. For example, the cross-sectional variation of stock returns across countries can be partly explained by a global value factor [6]. Such a value effect has been observed across many different markets, regions and sample periods [1]. In this paper, we use a combination of several common valuation measures to capture the value premium. We assess forecast measures of Earnings Yield, Book to Price, Cash Flow Yield, Sales to Price and Dividend Yield. All valuation measures are calculated on a 12-month forward basis using IBES estimates. We find a value premium that is economically significant using both absolute and relative measures of value. However, the ability to capture any value premium varies across valuation measures. In terms of absolute measures of value, Earnings Yield is the most significant, followed by Cash Flow Yield, Sales to Price, Book to Price and finally Dividend Yield. Country relative measures of value are generally comparable to absolute measures of value in their ability to identify a value premium: the exceptions are Earnings Yield which is poorer and Sales to Price, which is superior to its absolute measure. Furthermore, when value is measured by Earnings Yield, Cash Flow Yield and Sales to Price, value effects are relatively persistent over time. The strength and persistency of individual value effects and levels of correlation amongst individual valuation measures suggest that a combination of Earnings Yield, Cash Flow Yield and Sales to Price is appropriate.
    [Show full text]
  • The Relationship Between Earnings' Yield, Market
    Journal of Financial Economics 12 (1983) 129-156. North-Holland THE RELATIONSHIP BETWEEN EARNINGS’ YIELD, MARKET VALUE AND RETURN FOR NYSE COMMON STOCKS Further Evidence* Sanjoy BASU** McMaster University, Hamilton. Onl., Canada LHS 4M4 Received October 1981, linal version received August 1982 The empirical relationship between earnings’ yield, firm size and relurns on the common stock ol NYSE firms is examined in this paper. The results conlirm that the common stock of high &P firms earn, on average. higher risk-adjusted returns than the common stock of low E/P lirms and that this efiect is clearly significant even if experimental control is exercised over difTcrcnces in lirm size. On the other hand, while the common stock of small NYSE lirms appear to have earned substantially higher returns than the common stock of large NYSE lirms, the size efTect virtually disappears when returns are controlled for differences in risk and E/P ratios. The evidence presented here indicates that the E/P effect, however, is not entirely independent of firm size and that the effect of both variables on expected returns is considerably more complicated than previously documented in the literature. 1. Introduction Recent empirical research on the relationship between earnings’ yield, firm size and common stock returns has revealed some anomalies with respect to the pricing of corporate equities. In particular, the findings reported in Basu (1975, 1977) indicate that portfolios of high (low) earnings’ yield securities trading on the NYSE appear to have earned higher (lower) absolute and risk-adjusted rates of return, on average, than portfolios consisting of randomly selected securities.
    [Show full text]
  • Stock Market Valuations – Theoretical Basics and Enhancing the Metrics
    Deutsche Bundesbank Monthly Report April 2016 15 Stock market valuations – theoretical basics and enhancing the metrics With stock market volatility high, public debate has recently returned to the question of whether the current stock market valuation is appropriate. Developments in stock market valuations are also of interest from a monetary policy and financial stability angle. Dividend discount models, which are based on interest rates and dividend expectations and allow the implied cost of equity and equity risk premiums to be derived, provide a theoretical basis for investigating the appropri- ateness of the valuation level. Essentially, these models attribute movements observed in equity prices to changes in the individual model components. However, by providing the implied cost of equity and equity risk premiums, dividend discount models deliver more than just a gauge for stock market valuations and market players’ attitude to risk. Developments in individual model components also help assess the broader economic environment for corporates. The present art- icle takes the usual valuation approaches a step further by focusing on maturity- specific interest rates and analyst dividend expectations. As measured by the implied cost of equity, the DAX’s valuation was slightly below its ten- year average at the end of March 2016. By contrast, the equity risk premium was comparatively high, at 7½%, and close to the implied cost of equity. The small gap between these two metrics is probably mainly due to the current low-inter est- rate environment. Moreover, it should be noted that the valuation level and the assessments derived therefrom are based on the assumption that the survey-based earnings and dividend forecasts correctly reflect market expectations, which need not necessarily be the case.
    [Show full text]
  • Returns to Buying Earnings and Book Value: Accounting for Growth and Risk
    Returns to buying earnings and book value: Accounting for growth and risk Stephen Penman* Graduate School of Business, Uris 612 Columbia University 3022 Broadway New York NY 10027 USA [email protected] Francesco Reggiani Department of Accounting Bocconi University Via Roentgen Milano 20136 Italy [email protected] June 2008 Revised February 2013 *Corresponding author. We thank Jeff Abarbanell, Andrew Ang, Sanjeev Bhojraj, Ilia Dichev, Takashi Obinata, Keywan Rasekhschaffe, and Scott Richardson for comments. Stephen Penman thanks Bocconi University, the Swedish Institute for Financial Research, and the Guanghua School of Management at Peking University for providing facilities during a sabbatical when this paper was written. Francesco Reggiani thanks the Center for Research on Corporate Administration, Finance and Regulation at Bocconi University for research support. Abstract. Historical cost accounting deals with uncertainty by deferring the recognition of earnings until the uncertainty has largely been resolved. Such accounting affects both earnings and book value and produces expected earnings growth deemed to be at risk. This paper shows that the earnings-to-price and book-to-price ratios that are the product of this accounting forecast both earnings growth and the risk to that growth. The paper also shows that the market pricing of earnings and book values in these ratios aligns with the risk imbedded in the accounting: the returns to buying stocks on the basis of their earnings yield and book-to-price are explained as a rational pricing of the risk of expected earnings growth not being realized. Accordingly, the paper provides a rationalization of the well-documented book-to-price effect in stock returns: book-to-price indicates the risk in buying earnings growth.
    [Show full text]