Stock Market Valuation Models
               and
the Composite Valuation Indicator



         Karel Tregler, Ph.D.



   ...
Content



       I.   What are Stock Market Valuation Models (SMVMs)?
       II. Why are SMVMs important for investment p...
I. What are Stock Market Valuation Models?

         Stock Market Valuation Models (SMVMs) measure overvaluation or
      ...
I. What are Stock Market Valuation Models?


          The next page shows an example of graphed output from one of
      ...
I. What are Stock Market Valuation Models?
                This valuation indicator is based on the well-known Yardeni‘s s...
II. Why are SMVMs Important for Investment
    Professionals?
              SMVMs are an essential part of the Asset Alloc...
II. Why are SMVMs Important for Investment
   Professionals?
ASSET ALLOCATION PROCESS:
                                   ...
III. What is a Composite Valuation Indicator?

           Results of the 18 SMVMs can be synthesized into a unique
       ...
MODEL NUMBER (Names of all 18 models can be found in the Appendix II)
                                                    ...
III. What is a Composite Valuation Indicator?

           A Composite Valuation Indicator is my synthesis of
           ou...
III. What is a Composite Valuation Indicator?
                  The Composite Valuation Indicator measures by how much
   ...
Appendix I

  Karel Tregler, Ph.D.
      Graduate of the Prague School of Economics
      Doctorate received in 2004
     ...
Appendix II
  Names of the 18 Stock Market Valuation Models
  1.    Dividend Yield Model
  2.    Expected Risk Premium Mod...
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Stock Market Valuation Models (English)

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What are Stock Market Valuation Models (SMVMs)?
Why are SMVMs important for investment professionals?
What is a Composite Valuation Indicator?

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Stock Market Valuation Models (English)

  1. 1. Stock Market Valuation Models and the Composite Valuation Indicator Karel Tregler, Ph.D. November 2007
  2. 2. Content I. What are Stock Market Valuation Models (SMVMs)? II. Why are SMVMs important for investment professionals? III. What is a Composite Valuation Indicator? SMVMs and the Composite Valuation Indicator 2
  3. 3. I. What are Stock Market Valuation Models? Stock Market Valuation Models (SMVMs) measure overvaluation or undervaluation of an equity market relative to its fair value. During 3 years of extensive research I have identified and analyzed 18 different SMVMs and I have sorted them into the following groups based on their similarities: equity risk premium models models based on earnings yield and bond yields models based on accounting multiples models based on technical analysis models based on psychological analysis Every model has its own definition of “fair value” of the stock market or the stock market index. SMVMs and the Composite Valuation Indicator 3
  4. 4. I. What are Stock Market Valuation Models? The next page shows an example of graphed output from one of the SMVMs. Such an indicator of over- and undervaluation of the stock market can be constructed for each of the 18 models. As we can see, the indicator has identified all the famous bubbles and crashes since 1979. Results of the SMVMs can be then synthesized into a graphical table and into a Composite Valuation Indicator (see chapter III). SMVMs and the Composite Valuation Indicator 4
  5. 5. I. What are Stock Market Valuation Models? This valuation indicator is based on the well-known Yardeni‘s stock market valuation model (this model has been used by Deutsche Bank and by Prudential Financial) 80 1 600 Stock Market Valuation Indicator based on Yardeni's model (left axis) points % S&P 500 (right axis) 60 1 400 1987 Bubble 2000 Dot Com Technology Bubble 40 1 200 OVERVALUED 20 1 000 0 800 -20 600 UNDERVALUED Sept. 11, 2001 -40 400 Stagflation, Oil Crisis LTCM and the Accounting scandals, -60 200 Russian Default Market Capitulation -80 0 I-79 I-80 I-81 I-82 I-83 I-84 I-85 I-86 I-87 I-88 I-89 I-90 I-91 I-92 I-93 I-94 I-95 I-96 I-97 I-98 I-99 I-00 I-01 I-02 I-03 SMVMs and the Composite Valuation Indicator 5
  6. 6. II. Why are SMVMs Important for Investment Professionals? SMVMs are an essential part of the Asset Allocation Process (see next page) SMVMs are the key quantitative inputs for any strategic asset allocation decision, i.e. how much will be invested in equities compared to other asset classes. SMVMs are used by equity strategists or analysts to estimate the expected returns or levels of an equity market index in the future. Some of the SMVMs are forward looking, so they have an important predictive ability. SMVMs and the Composite Valuation Indicator 6
  7. 7. II. Why are SMVMs Important for Investment Professionals? ASSET ALLOCATION PROCESS: Is the stock market Global Macroeconomic Analysis over- or undervalued? SMVMs are applied. Strategic Allocation Analysis Bonds Equities Real Estate Other Industry Analysis Company Analysis SMVMs and the Composite Valuation Indicator 7
  8. 8. III. What is a Composite Valuation Indicator? Results of the 18 SMVMs can be synthesized into a unique graphical table and into a Composite Valuation Indicator The graphical table on page 9 is constructed in the following way: columns represent models, lines represent months. Orange indicates months with the highest overvaluation and blue indicates months with the largest undervaluation. LEGEND: Highly overvalued market Highly undervalued market Market is close to its fair value Data not available The Dot Com Technology Bubble can be seen immediately Names of all 18 models are listed in Appendix II SMVMs and the Composite Valuation Indicator 8
  9. 9. MODEL NUMBER (Names of all 18 models can be found in the Appendix II) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 YEAR 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 SMVMs and the Composite Valuation Indicator 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 III. What is a Composite Valuation Indicator? 2002 ; 2003 2004 9
  10. 10. III. What is a Composite Valuation Indicator? A Composite Valuation Indicator is my synthesis of outputs of the 18 stock market valuation models (page 11). It is basically an equally weighted index of the individual valuation indicators. The Composite Valuation Indicator identifies several time periods, which had been recognized by economists ex-post as times when the stock market was heavily under- or overvalued. The Composite Valuation Indicator clearly identified the major market bubbles and crashes of the past 100 years (see next page). SMVMs and the Composite Valuation Indicator 10
  11. 11. III. What is a Composite Valuation Indicator? The Composite Valuation Indicator measures by how much and when the stock market was over- or undervalued % 140 2000 Dot Com Technology Bubble 120 1929 Buble 100 Nifty Fifty Bubble 80 Copper Mines Craze 1987 Bubble OVERVALUED 60 40 20 0 -20 -40 UNDERVALUED -60 War in Korea 1907 Crash -80 1903 Crash Stagflation, Oil Crisis -100 1st World War OPEC -120 Post-war Fed Increases Embargo Financial Crisis, Beginning Recession the Minimum 2nd World -140 of the Great Depression Reserves, 1937 1969-1970 Crash War -160 1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 SMVMs and the Composite Valuation Indicator 11
  12. 12. Appendix I Karel Tregler, Ph.D. Graduate of the Prague School of Economics Doctorate received in 2004 Currently employed as an Equity Portfolio Manager at PPF Asset Management in Prague PPF Asset Management has approx. 7 bn. USD under management Detailed analysis and subsequent synthesis of the SMVMs was first presented in my dissertation in November 2004 A few months later the dissertation was published by C.H. Beck publishing (www.chbeck.cz) Contact details: email: tregler@ppf.cz SMVMs and the Composite Valuation Indicator 12
  13. 13. Appendix II Names of the 18 Stock Market Valuation Models 1. Dividend Yield Model 2. Expected Risk Premium Model à la Dresdner Kleinwort Wasserstein (since 1874) 3. Graham & Dodd P/E Model 4. Current P/E Model 5. Tobin‘s Q Model 6. Asness Model 7. E-STAR Model 8. Historical Risk Premium Model 9. Yardeni‘s Fed Model (SVM 1) 10. Normalized Fed Model a la Dresdner Kleinwort Wasserstein 11. Cumulated Market Returns Ratio 12. Expected Risk Premium Model à la Dresdner Kleinwort Wasserstein (since 1980) 13. PEG Model 14. Forward P/E Model 15. Yardeni‘s SVM 2 Model 16. Three Stage Expected Risk Premium Model a la Société Générale 17. Valuation Confidence Index Model 18. Implied Volatility Model SMVMs and the Composite Valuation Indicator 13

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