Stock Recommendations from Stochastic Discounted Cash Flows
16 Pages Posted: 1 Jul 2020 Last revised: 30 Mar 2021
Date Written: June 7, 2020
We present two stock recommendation systems based on stochastic characterization of firm present value that extends the conventional discounted cash flow analysis. The single-stock quantile recommendation system compares the market price of a company's stocks with the estimated distribution of the company's fair value to obtain an individual measure of mispricing, while the cross-sectional quantile system builds a relative measure of mispricing using the fair-value distribution of all firms. Both systems use mispricing information to build sell side and buy side portfolios. Statistical tests show that these portfolios consistently deliver significant excess returns even when rebalancing costs are accounted for. Moreover, we show how analysts' indications can be improved by using the first two moments of their recommendations following the same procedure of the cross-sectional quantile system.
Keywords: Stochastic Discounted Cash Flow, Asset Valuation, Valuation Uncertainty, Portfolio Strategy
JEL Classification: G11, G17, G32
Suggested Citation: Suggested Citation