I will now examine the effectiveness of the Book to Market ratio in predicting stock market returns. The Book to Market ratio is used to compare the book value and the market value of the firm. The book value is calculated by the firm’s accounting worth. The market value is determined by the market capitalization in the stock market. It is then found using the formula, Book Value of the firm / Market Value of the firm. Its purpose is to identify any securities that may be undervalued or overvalued. From the research of Fama and French (1992), we can see the cross sectional variation in stock returns can be shown by the book to market ratio of individual stocks. In Pontiff (1998), there were two measures of the book to market ratio that were used. One was the Dow Jones Industrial Average (DJIA) and the other was the Standard and Poor (S&P) Index. The DJIA book to market ratio’s ability of prediction is more precise for the years prior to 1960 while the S&P book to market ratio gives a predictive ability for the period after 1960. However, S&P’s relation is dramatically weaker than DJIA’s findings for the period before 1960 (Pontiff 1998, Page 141). A major reason for the book to market ratio’s ability to predict stock market returns is that book value acts as a proxy for future cash flows. We know that if we divide a cash flow proxy by the current market price, a variable is produced that can be correlated with future market returns. If better proxies are used, the correlation is even greater. Dividing the book value which is considered to be a future cash flow proxy by the price level or the market value gives us a proxy for the discount rate. If we take an aggregate measure of the book to market ratio, we can say that it predicts...
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The Smith & Wesson Holding Corporation stock has an EPS of 1.42 and a P/E ratio of 10.52. Upon running a regression, a coefficient of 0.139 was calculated. This means that if the SWHC stock increases by 1%, the S&P 500 stock will increase by 0.139%.When compared against the S&P 500 index, the SWHC stock has a correlation of 16.3%. This is relatively low. The SWHC stock can explain approximately 16.3% of the variation in the S&P 500. In other words, the stock does not behave the same as the S&P 500 and should not be used to predict the S&P 500. There is about 83.7% of the...
Troy, PhD., Leo. Almanac of Business and Industrial Financial Ratios. 29th edt. (1998) (page 159) Paramus, NJ: Prentice Hall.
America is divided into social groups based on the income and financial assets of its citizens. One of the groups which forms part of the social system are the “mass affluent.” The mass affluent are portrayed as people who make more than the mass market, but less than one million. Mass affluent households generally hold from 250,000 to 1 million in income and financial liquid assets. More than 13 million households in the U.S. are mass affluent accounting for 11 percent of all U.S households (Nielsen.com).The mass affluent are the largest group part of the wealth management segment. The mass affluent social group falls between the middle class and the wealthiest of consumers. The typical mass affluent consumers is usually white, married, holds a white collar job and lives in a two income household with one child. The mass affluent are characterized as individuals who live a distinct lifestyle compared to the rest of the consumer market when it comes to financial preferences and media consumption. This social group lives in the suburbs, are empty nesters and form part of the baby boomer generation. Consumers part of the mass affluent hold white collar jobs in finance, business management and hold multiple investment accounts. Well-educated and very sophisticated these consumers do not classify themselves as rich. These individuals do not classify themselves as rich but have multiple investment accounts including 401k, IRAs, and CDs. The typical mass affluent consumer does not take many shopping trips but spends more money on each trip than the average customer (Nielsen.com). Two thirds of the mass affluent are 55 years old and older which is why so many are turning to IRAs. The mass affluent social group with approximately 22 mill...
...phases. Fabozzi and Francis (1977) conducted a study testing the differential effect of bull and bear market conditions for 700 individual securities listed on the NYSE. It was found that the estimated betas of most of the securities were stable in both market conditions. However, Ray (2010) conducted a similar study over a period of ten years using monthly returns of 30 stocks. The results obtained were both mixed and inconclusive. Bowie and Bradford (1997) found that the tests of beta stability are difficult to interpret on their own. Gombola and Kahl (1990) suggest that an OLS estimate of beta requires an estimation period during which the relationship between the market return and the stock return remain stable. However, without this stability, an alternative for forecasting a time-varying relationship such as the Bayesian adjustment process will be required.
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In turn everything in the present and the future is judged through the stocks as they hold a high importance in industrialized economies showing the healthiness of said countries economy. As investing discourages consumer spending over all decreases, it lead...
The article Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy was written in 1968 by Edward I. Altman. The purpose of the article is to address the quality of ratio analysis as an analytical technique. At the time, some academicians were moving away from ratio analysis and moving toward statistical analysis. The article attempted to determine if ratio analysis should be continued, eliminated and replaced by statistical analysis or serve together with statistical analysis as cofactors in financial analysis. The example case used in the article was the prediction of corporate bankruptcy.
Capital Asset Pricing Model (CAPM) is an ex ante concept, which is built on the portfolio theory established by Markowitz (Bhatnagar and Ramlogan 2012). It enhances the understanding of elements of asset prices, specifically the linear relationship between risk and expected return (Perold 2004). The direct correlation between risk and return is well defined by the security market line (SML), where market risk of an asset is associated with the return and risk of the market along with the risk free rate to estimate expected return on an asset (Watson and Head 1998 cited in Laubscher 2002).
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Recently a new trend has taken up Wall Street. Savvy broker firms have realized that the market is probably controlled by some rules, and those rules have to be found to make more money with the least risk. They hired many mathematicians to look for any formulas that would seem to express the market. Those analyzed previous market trends and used laws of statistics to try to predict the “future” of the market. The funny thing is that at times this approach actually worked. It yielded a slightly more than fifty percent accuracy, and that was enough. (When dealing with tremendous amounts, even a small percentage is not meager.)
Chapter 11 closes our discussion with several insights into the efficient market theory. There have been many attempts to discredit the random walk theory, but none of the theories hold against empirical evidence. Any pattern that is noticed by investors will disappear as investors try to exploit it and the valuation methods of growth rate are far too difficult to predict. As we said before the random walk concludes that no patterns exist in the market, pricing is accurate and all information available is already incorporated into the stock price. Therefore the market is efficient. Even if errors do occur in short-run pricing, they will correct themselves in the long run. The random walk suggest that short-term prices cannot be predicted and to buy stocks for the long run. Malkiel concludes the best way to consistently be profitable is to buy and hold a broad based market index fund. As the market rises so will the investors returns since historically the market continues to rise as a whole.
The efficient market hypothesis has been one of the main topics of academic finance research. The efficient market hypotheses also know as the joint hypothesis problem, asserts that financial markets lack solid hard information in making decisions. Efficient market hypothesis claims it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information . According to efficient market hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments . In reality once cannot always achieve returns in excess of average market return on a risk-adjusted basis. They have been numerous arguments against the efficient market hypothesis. Some researches point out the fact financial theories are subjective, in other words they are ideas that try to explain how markets work and behave.
The ratios returns on investment (ROI) and return on equity (ROE) are two of the most popular measure of profitability of a company and, along with the P/E ratio, have the most significant value of any of the ratios. The DuPont Model expands on the ROI calculation by inserting sales and it's relationship to the companies' generation of profits and utilization of assets into the calculation. Additional profitability ratios include the price earnings ratio (P/E), the dividend payout and the dividend yield. The price earnings ratio helps to indicate to investor how expensive the shares of common stock of a firm are. Dividend yield is part of the stockholders ROI and is represented by the annual cash dividend. Dividend yields have historically been between 3% to 6% for common stock and 5% to 8% for preferred stock. Dividend payout ratio shows the proportion of the earnings paid to common shareholders. Dividend payout for manufacturing companies range from 30% to 50%, but can vary widely.
In the modern world, financial markets play a significant role, with huge volumes of everyday dealings. They form part of contemporary economic lifestyle and determine the level of success of many people. Humans have always been uncertain of what the future holds and thus, tried to forecast it. The forecast of course cannot omit the likelihood of “easy money” by forecasting the prices of equity markets in the future.