Stock Prices, Earnings, and Expected Dividends

Core Idea:

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.

Alpha Highlight:

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).

2014-10-02 10_53_04-0Value Reseach Recap.pptx - Microsoft PowerPoint (Product Activation Failed)

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

2014-10-02 10_54_15-0Value Reseach Recap.pptx - Microsoft PowerPoint (Product Activation Failed)

The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index. Additional information regarding the construction of these results is available upon request.

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