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I like to play around with valuation calculations. I started by comparing the stock yield to the bond yield and had some interesting results, but people are much more willing to pay more for bonds than stocks.
In an effort to find the current market valuation, rather than a historic valuation, I looked at the current stock prices compared to various factors. The stocks I looked at are the common stocks out of my shortlist and watchlist.
By far the best correlation was with the market average forward price to earnings ratio.
Taking out the forward price to earnings effect, I looked at other factors. There is a small correlation with Beta (a zero volatility stock will have a 20% premium over an average volatility stock), which isn't surprising. What did surprise me was that there was a negative correlation to yield, while there was no correlation for more fundamental factors such as debt, payout ratio, and earnings growth. I can understand that people are more concerned about a stock as the yield goes up, but you would expect some fundamental factor to contribute to this concern.
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KenBob, that is interesting. Probably more work than it's worth but but I would like to see a broader elucidation on your thesis.
For example, various beta levels vs. ???? Or at what point does yield affect pricing of risk assets vs. non-risk assets; e.g., T bills/bonds. You have any more specifics or insights to share?
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“While the dividend itself is merely a rearrangement of equity, over time it's more like owning an apple tree. The tree grows the apples back again and again and again, and the theoretical value of the tree doesn't change just because of when the apples are about to fall.” - earthtodan
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This wasn't an academic study. I just took the data in my Excel sheet for the stocks I follow and curve fitted them. My idea is that you should be able to see factors that affect the current price by curve fitting a line of price versus a given factor. For a factor to be relevant the datapoints should be evenly distributed about the line and as tight to the line as possible.
The best fit is using the forward PE ratio.
I then normalized the price by taking the stock's forward PE and dividing by the market's average forward PE (available from the Wall Street Journal website). Looking at this data allows me to look for more minor correlations. Doing this I found the two correlations mentioned.
I gave the result for the Beta correlation, but I hesitate to give the exact yield correlation, since I can't normalize it. The line for the data I used resulted in 3% yield at the average forward PE ratio, which matches the target I tend to use for selecting stocks. The actual curve parameters are probably dependent upon stock selection; however, I found the trend interesting.
With the Beta correlation, I get market value of a stock as (1.2 - 0.2 x Beta) x Forward Earnings x Market Average Forward PE. I expect the stock prices to vary about this calculated value, giving me a means of determining if it is over or under valued.
You can use this if you wish, but I really don't have the time to go much deeper.
As there is so little for me to record (dividends received, any increases, & re-investments), that there is nothing wrong with looking at different evaluations to kill time. Even when I was in the accumulation mode, I'd only check the companies I were interested in quarterly for drop in cashflow, change in payout or changes in dividend policy.
KenBob's findings seem to follow along with base principles.
Assumption: people prefer less variance to more variance in their investments
1st Result: Bonds are seen as more stable than stocks, hence the finding that people pay more for bonds
2nd Result: Stocks with lower beta (less variance) are valued higher than stocks with higher beta
Valuing a company based on forward P/E:
The underlying value of a stock is the present value of the sum of expected future cash flows (dividend discount model)
This shows up in the denominator of the forward P/E = price / forward expected earnings
Why Kenbob may be seeing the total stock price being related to beta, average market p/e, and individual stock p/e:
Capital Asset pricing model tells us that:
Expected return of an asset = Risk free rate + beta * (average market rate - Risk free rate)
Translate into dividend stock...
(Div Yield + expect stock appreciation %) = yield of U.S. treasury bond + beta of stock * (average market return - yield of U.S. treasury bond
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(01-30-2016, 08:20 AM)benjamen Wrote: Assumption: people prefer less variance to more variance in their investments
1st Result: Bonds are seen as more stable than stocks, hence the finding that people pay more for bonds
2nd Result: Stocks with lower beta (less variance) are valued higher than stocks with higher beta
Why Kenbob may be seeing the total stock price being related to beta, average market p/e, and individual stock p/e:
Capital Asset pricing model tells us that:
Expected return of an asset = Risk free rate + beta * (average market rate - Risk free rate)
Translate into dividend stock...
(Div Yield + expect stock appreciation %) = yield of U.S. treasury bond + beta of stock * (average market return - yield of U.S. treasury bond
I think many DGI'ers don't equate beta with risk. You can't really come up with a number (i.e. 1.5) and say that's the risk. Beta measures price volatility against a benchmark, say the S&P 500. Price volatility doesn't equal risk.
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I am beginning to incorporate P(rice)/C(ash) F(low) as a significant valuation tool.
Anybody else using this at all, it seems to make a LOT of sense particularly for dividend investors.
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I look at it as I narrow down choices. I prefer the P/CF be less than P/E; the greater the difference the better. However, I also take into account what's going on in their respective industry. The oil patch comes immediately to mind where there's now not much of either: earnings or cash flow. They end up selling assets, of which there are many when it comes to the majors, to support the business.
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“While the dividend itself is merely a rearrangement of equity, over time it's more like owning an apple tree. The tree grows the apples back again and again and again, and the theoretical value of the tree doesn't change just because of when the apples are about to fall.” - earthtodan
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(10-09-2016, 11:34 AM)Dividend Watcher Wrote: I look at it as I narrow down choices. I prefer the P/CF be less than P/E; the greater the difference the better. However, I also take into account what's going on in their respective industry. The oil patch comes immediately to mind where there's now not much of either: earnings or cash flow. They end up selling assets, of which there are many when it comes to the majors, to support the business.
I consider P/FCF, but I only compare companies against other companies in their industry. Visa's FCF is going to be wildly different than the FCF of an industrial or tech company.
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