Stock Prices, Earnings, and Expected Dividends
- Campbell and Shiller
- A version of the paper can be found here.
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Price-earnings ratios and dividend-price ratios are useful for forecasting future stock price changes.
- The core premise is that valuation ratios will fluctuate within their historical ranges in the future; when a ratio is at an extreme level, it will mean revert, and either the numerator or the denominator are forecastable.
- Dividend-price ratios are a poor predictor of future dividend growth (R-square = 0.25%); however, dividend-price ratios are a much stronger predictor of future real price changes (R-square = 63%).
- Price-smoothed-earnings ratios also have special significance.
Faber (2012) applied this valuation metric across more than 30 foreign markets and finds it both practical and useful. Below are two charts from Faber (2012).
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