Final Flashcards
Price to Earnings
indicates how much investors are willing to pay for each dollar of earnings
Why is something cheap relative to its current dividends?
expected growth in cashflows is low
discount rate is high
Low P/D Stocks
are cheap
low growth, high expected return
“growth stocks”
High P/D Ratio Stocks
are expensive
expected growth is high
expected return is low
“value stocks”
Sorting Stocks on P/E Ratio
we find that value stocks outperform growth stocks
CAPM Predicts
that no stock should consistently earn alpha
SMB - Small Minus Big
goes long small stocks financed with a short position in big stocks
HML - High Minus Low
goes long value stocks financed with a short position in growth stocks
Buffet
find cheap stocks, ignore short term fluctuations
they have lower beta
loading on growth not value
Value Factor
High Book to Market - Low Book to Market
High Book-to-Market ratio means the market value looks low
• Go long these cheap stocks, short expensive stocks. Classic value strategy. • Sometimes referred to as “Value-minus-Growth”.
High Book to Market
means the market value looks low
long cheap stocks, short expensive stocks
Long Short Strategies
are hard to execute in practice
Arbitrage Pricing Theory
Different forces in the economy affect the price of an investment.
If the investment is priced unfairly (too high or too low), investors will act to profit from the difference, and this “arbitrage” will eventually bring the price back to a fair level.
It’s a more flexible model than others because it looks at multiple factors, not just one
Low Expected Return
increases the P/D ratio
discount rate is smaller
Low Expected Future Dividend Growth
lowers the P/D Ration because value of the stock (price) is derived from the present value of its future dividends. If dividends are expected to grow slowly, the price will not increase as much, lowering the P/D ratio.
