Overview of Equity Investing and Value Investing.ppt by pptfiles

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									Yale School of Management




            Overview of Equity Investing
                and Value Investing

                          William N. Goetzmann
                        Yale School of Management
Yale School of Management




                            Equity Investing

      lMotivation and Benefits
      lLong-Term Performance
      lPortfolio Approach to Performance
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                     Why Equity Investing?

      lHistory
      lGrowth
      lLiquidity
      lDiversification
      lLegal rights
      lAligned interests
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               Three Centuries of Equities
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                      U.S Financial Markets
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                     Capital Market History
                          1926 - 1996
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       The Equity Premium: 1970-1996
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             Active vs. Passive Investing

      lValue added through information
      lUncertainty of information
      lMarket efficiency
      lDoes relative skill exist?
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                        Do Winners Repeat?

      lGoetzmann and Ibbotson 1994 study
      lUsed 1976 - 1992 data
      lFound good & bad performance persists
      lFound that active managers beat the
       Vanguard S&P 500 Index over the period
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           Evidence on Active Investing
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           Basics of Active Management

      lMarket timing
      lSecurity selection
      lDiversification
      lTaxes
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                            Market Timing

      l Little evidence of widespread timing skill
            ù survivors appear to have done well
            ù market timing letters show no skill


      l The Dow theory: a momentum play
            ù some evidence of timing ability
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                            The Dow Theory

      lClassic timing strategy of equity investment
      lPopularized by the Wall Street Journal from
       1903 through 1929
      lA momentum strategy
            ù market follows trends
            ù Industrial and transportation sectors confirm
            ù high volume indicates move
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          The Dow Theory 1903 to 1929
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                            Bull vs. Bear Calls
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                            Security Selection

      l“Do Security Analyst’s Recommendations
       Have Value?” by Kent Womack JF (1996)
      lStudied broker recommendations over a
       decade
            ù Buy recommendations: 2% gain over days
            ù Sell recommendations: 9% loss over 6 months
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                            Value Investing

      l Value vs. growth
      l Quantitative approach to valuation models
      lPerformance of value stocks
      l Performance of value portfolios
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                     Valuation of Perpetuity

      lV = C/(1+R) + C/(1+R)2 + … + C/(1+R)T

      l When T approaches infinity:

      l V = C/R
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              The Law of Value Investing

      l C = Cash Flow
      l V = Firm Value
      l R = Discount Rate

      l C = V*R
      l V = C/R
      l R = C/V
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                            Assumptions

      lNo growth in cash flow
      lNo changing cash flow
      lNo changing discount rate
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                      Estimating Cash Flow

      l Dividends
            ù Yield = discount rate
            ù logic: Shareholders get dividends
            ù High yield firm is a value firm
      lEarnings
            ù E/P = discount rate
            ù logic: earnings measure increase is economic
              value of the firm
            ù High Book to Market is a “Value Firm”
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                            Example: EVA

      lEVA: Economic value-added
            ù net after-tax profit - capital*cost of capital
            ù C - V*R>0
                  l means  firm is undervalued, or:
                  l C is mis-estimated
                  l R is mis-estimated
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             Evidence on Value Investing

      lLong-term tests of DCF model
      lRobert Shiller (Yale)
            ù takes known future C/R and compare it to P
            ù finds P is more variable than C/R
            ù Market over-reacts
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        Under and Over-Valued Markets
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                 Does P/E Forecast for R?
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                       What About Growth?

      l Another Variable: G
            ù C grows at G
      l Uses analyst’s
        forecasts of growth
      l Growth firms are:
            ù Low yield
            ù Low earnings
            ù Low B/M
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                            Growth and Value

      lG = R - C/V
      lSuppose you had a growth forecast: G*
      lIncremental return = G* - G
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                            Estimating Growth

      lIbbotson and Riepe, 1997
      lHow well do you do by perfectly
       forecasting growth?
      l Is growth sufficient?
      lHow right do you have to be?
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                  Perfect Foresight Growth
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                   Value vs. Growth Stocks
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              Value vs. Growth Managers

      lMutual fund style analysis (Brown and
       Goetzmann, 1997)
      lIdentified equity mutual fund styles
      lValue, Growth & Glamour managers
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                            Glamour Managers

      lHigh growth and small stocks
            ù   P/E ratio = 24.00
            ù   Market to book= 4.29
            ù   Five yr. earnings growth = 23.59
            ù   11 year risk-adjusted performance:
      lPerformance = .51 % excess return per year
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                            Value Managers

      lHigh value, small stocks
            ù P/E ratio = 20.2
            ù Market to book = 3.21
            ù Five yr. earnings growth = 9.92
      lPerformance = 2.25 % excess return per
       year
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          How About the Discount Rate?

      lR = G + C/V
      l How is it estimated?
      lAsset pricing models
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            Summary of Equity Investing

      lOld evidence on timing
      lNew evidence on selection
      lQuantitative model of value
      lValue vs. growth stocks
      lValue vs. growth managers
      lDiscount rate

								
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