It would be nice, before quoting alternative valuation models, if Wall Street analysts would at least present similarly broad historical evidence that their methodology actually has
a relationship with subsequent market returns.
Ignore clever - sounding valuation arguments that don't have a strong, consistent, and demonstrated
relationship with subsequent market returns.
Regardless of whether an analyst claims that stocks are cheap or expensive, they should be expected to provide some sort of evidence that their methods have a strong
relationship with subsequent market returns.
While this comparison has captured certain periods of extreme overvaluation, it is a useless predictor, in terms of its overall
relationship with subsequent market returns.
Not exact matches
While there is a general tendency for high interest rates to be associated
with depressed valuations and above - average
subsequent market returns, and for low interest rates to be associated
with elevated valuations and below - average
subsequent market returns, the
relationship isn't extremely reliable or linear.
This adjustment has historically been important, as adjusting for that embedded profit margin significantly improves the
relationship between the CAPE and actual
subsequent market returns (something we can demonstrate both
with algebraic
return estimates and regression models — see Margins, Multiples, and the Iron Law of Valuation).
Don't criticize historically reliable valuation measures that have maintained the same tight
relationship with actual
subsequent 10 - 12 year
market returns that they've demonstrated across a century of history.
Only those who are historically uninformed believe that valuations have no
relationship to
subsequent returns, or place their faith in scraps of analytical debris like the «Fed Model» without examining their poor correlation
with actual
subsequent market returns.
In contrast, I've often quoted the Shiller P / E (which essentially uses a 10 - year average of inflation - adjusted earnings) as a simple but historically informative alternative, but I should emphasize that we strongly prefer our standard methodologies based on earnings, forward earnings, dividends and other fundamentals, all which have a fairly tight
relationship with subsequent 7 - 10 year total
returns (see Lessons from a Lost Decade, The Likely Range of Market Returns in the Coming Decade, Valuing the S&P 500 Using Forward Operating Earnings, and No Margin of Safety, No Room for
returns (see Lessons from a Lost Decade, The Likely Range of
Market Returns in the Coming Decade, Valuing the S&P 500 Using Forward Operating Earnings, and No Margin of Safety, No Room for
Returns in the Coming Decade, Valuing the S&P 500 Using Forward Operating Earnings, and No Margin of Safety, No Room for Error).