Stock Valuation Model
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Why is the Stock Valuation Model superior to traditional equity valuation models such as dividend-discount models, earnings-discount models and cash-flow discount models?
What sets the ValuEngine Valuation Model apart from variants of traditional discount models is a reasonable parameterization of each firm's EPS growth and the economy's interest-rate processes, plus the way in which these parameters are estimated. This is also why our proprietary model performs better than all other equity-valuation models available in identifying truly undervalued, profitable stocks.
Many research studies have demonstrated that the traditional discount models usually do not help much in finding profitable stock opportunities.
Our model valuation not only captures the properly discounted value of a stock's future EPS flow, but also reflects how the market has historically valued the stock in relation to interest rates, and current and expected future EPS. In addition, it takes into account the stock's liquidity and supply demand factors.
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What are the fundamental variables used in the Stock Valuation Model?
There are three basic variables utilized in the ValuEngine Stock Valuation Model:
  • The most recent, trailing 12-month earnings-per-share information (EPS) of the stock from the day of valuation,
  • The most recent forecasted EPS of the company for the future 12-months (based on analyst consensus) from the day of valuation, and
  • The current 30-year Treasury yield.
The values of these three variables can change slightly or drastically from day-to-day for any given stock. These changes in the value of any or all of the variables are dependent upon the current and future prospects for the company and the macro economy. Consequently, a stock's model price is subject to change on a daily and intra-day basis.
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Are there any other parameters playing a role in determining a stock's model price?
Yes, there are seven firm-specific and three interest-rate parameters that are all determinants of a stock's fair value today, though the importance of each differs across the parameters.
The firm-specific parameters reflect, among other things, its long-term EPS growth, its actual-EPS growth stability, the nature of the firm's business cycle, the volatility or stability of analyst expectations about its future EPS growth, and sensitivity to macroeconomic risk factors. These EPS parameters differ from firm to firm and across business sectors, giving the model ample flexibility to capture each stock's distinct characteristics.
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How are the model parameters estimated?
The model parameters for each stock are all estimated from the stock's own history, reflecting not only the business characteristics of the firm, but also the usual supply-demand situation for the stock by market participants. The resulting model price thus captures the firm's fundamental soundness, management effectiveness, and the implicit historical valuation standard of the stock by the market.
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Can the Stock Valuation Model be applied to IPOs or newly issued stock?
ValuEngine recommends that investors refrain from applying the ValuEngine Valuation Model to newly issued stocks or young stocks (those that have been publicly traded for less than two years). The ValuEngine Valuation Model requires at least two years of information to arrive at plausible projections.
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How often does a stock's model price change?
Because the values of the three fundamental variables can all change from day to day and intra-day for each stock, each stock's model price is subject to change on a daily and intra-day basis.
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What is the relative importance of Earnings Per Share (EPS) growth versus interest rate to model valuation?
In determining an individual stock's fair value, EPS and EPS growth are more important than interest rates.
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Is the quality of Earnings Per Share (EPS) estimates critical to determining the model price?
Not necessarily. The ValuEngine Valuation Model automatically adjusts for both accounting irregularities and EPS estimates from companies that are consistently inaccurate. Of course, the better the forecasts about a firm's future EPS, the more accurate the resulting model price for the stock.
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I have a stock with very high Price-to-Earnings (P/E) and market/book ratios, but ValuEngine.com says that it is undervalued. Why?
Traditionally, stocks are considered overvalued if they have a highP/E ratio and a high market/book ratio. In this particular case, the stock may be considered "overvalued" in the traditional sense. However, the ValuEngine Valuation Model is based in part on the stock's historical valuation in relation to interest rates and the stock's current and expected EPS. Consequently, if the stock is historically overvalued in the traditional sense, it's possible that once the stock price falls beneath its historic valuation level, it will be considered "undervalued" by the ValuEngine Valuation Model.
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My stock has very low Price-to-Earnings (P/E) and market/book ratios, but ValuEngine.com says that it is overvalued. Why?
Traditionally, stocks are considered undervalued if they have a low P/E ratio and low market/book ratio. In this particular case, the stock may be considered "undervalued" in the traditional sense. However, the ValuEngine Valuation Model is based in part on the stock's historical valuation in relation to interest rates and the stock's current and expected EPS. Consequently, if the stock is historically undervalued in the traditional sense, it's possible that once the stock price rises above its historic valuation level, it will be considered "overvalued" by the ValuEngine Valuation Model.
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Is the Stock Valuation Model's "model price" based on fundamentals or technical charting?
The ValuEngine model price for a given stock is based on the current fundamentals of both the company and the macro economy. However, the model price can be applied in conjunction with momentum and other relative-strength rankings included on this site.
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