Stock Valuation and Investment Strategies
55 Pages Posted: 26 Jul 2001
Date Written: June 30, 2001
Abstract
This article studies the relative investment performance of several stock-valuation measures. The first is mispricing based on the valuation model developed by Bakshe and Chen (1998)and extended by Dong (1998) (hereafter, the BCD model). The BCD model relates, in closed form, a stock's fair value to (i) the firm's net earnings per share (EPS). (ii) the expected future EPS growth and (iii) long-term rate. The second is a value/ price (V/P) ratio based on the Lee-Myers-Swaminathan (1999) residual-income model. The other measures are all indirect valuation indicators, including book/market (B/M), earnings/price (E/P), size, and past return momentum. These measures are shown to possess distinct properties. For example, the B/M, E/P and V/P ratios are highly persistent over time: high (low) B/M stocks tend to maintain high (low) B/M ratios. But, the BCD model mispricing is highly mean-reverting: an overpriced group will eventually become underpriced (in about 1.5 years on average), and vice versa. More importantly, the BCD model mispricing, momentum, size V/P and B/M are, in decreasing order, significant ex ante predictors of future returns. The best investment strategy is to combine the BCD model mispricing with momentum rankings. Indeed, if one would hold an equally-weighted portfolio of stocks that are the most underpriced and that have top momentum, the average monthly return from 1979 to 1996 would have been 3.18 percent, with a monthly Jensen's alpha of about 1.5 percent.
Keywords: Stock Valuation, Book/Market, Earnings/Price, Firm Size, Price Momentum, Stock Returns, Investment Management
JEL Classification: G10, G12, G131
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches
-
Estimating Standard Errors in Finance Panel Data Sets: Comparing Approaches
-
When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms
By Malcolm P. Baker, Jeffrey Wurgler, ...
-
When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms
By Malcolm P. Baker, Jeremy C. Stein, ...
-
When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms
By Malcolm P. Baker, Jeffrey Wurgler, ...
-
Stock Valuation and Learning About Profitability
By Lubos Pastor and Pietro Veronesi
-
Stock Valuation and Learning About Profitability
By Lubos Pastor and Pietro Veronesi
-
Stock Valuation and Learning About Profitability
By Lubos Pastor and Pietro Veronesi
-
Market Reactions to Tangible and Intangible Information
By Kent D. Daniel and Sheridan Titman
-
Market Reactions to Tangible and Intangible Information
By Kent D. Daniel and Sheridan Titman