Common Stock Valuation Research Articles

The Price-Future Earnings Ratio: A Practical Aid to Stock Valuation

(1958). The Price-Future Earnings Ratio: A Practical Aid to Stock Valuation. Financial Analysts Journal: Vol. 14, No. 4, pp. 25-28.

A Practical Approach to Common Stock Valuation

A PROBLEM WHICH HAS BEEN the subject of much study by security analysts as well as by investors in general is the determination of reasonably correct buying and selling levels for common stocks. The severe decline suffered by the stock market last year which followed promptly on the heels of one of its greatest advances, very appropriately points up the importance of this problem. Due to the fact that stocks generally approach extremes prior to the end of both bull and bear market movements, as a result of the over-enthusiasm and over-pessimism of the investing public, an analysis of the statistics of these advances and declines might conceivably furnish a clue to these over and under valuations.

A Statistical Approach to Formula Planning

FORMULA PLANS are supposed to be a set of Existing objective rules that enable the investor in common stocks to sell at relatively high levels of the cyclical fluctuations and buy at relatively low levels. Usually some trend in stock prices is considered as the or median value of common stocks, and bands above and below the normal value represent price levels where selling and buying, respectively, should take place. The main criticism of existing plans is that their performance has not been evaluated objectively. The evaluation of such plans can be done in two ways. One way is to assume that common-stock prices follow a well-defined model. For example, the time series is made up of a trend and fluctuations around the trend where both the trend and amplitude of the fluctuations are specified. Then one can determine whether or not a specific plan gives satisfactory performance for such a theoretical price series in the long run. The other possibility is to test the plan by applying it to the common-stock price series as it actually developed, using only the past data in making a decision at a particular time. Some of the existing plans have not been evaluated at all, whereas others have been evaluated unrealistically by making use of hindsight. Their performance in the past has been tested by using data for trend and amplitude that would have been available only in the future. The following formula plan is objective. It makes use of statistical tools which are especially suitable for this kind of analysis. The plan is so formulated that only past data and no hindsight are used in testing its performance. Furthermore, the reasoning on which the plan is based is consistent with principles of investment which are accepted in practice by many financial analysts.

Investment Value of Electrical Utility Common Stocks

THE DETERMINATION of reasonable investment values for common stocks assumes increasing importance as market price levels rise. If a stock is clearly and substantially undervalued, in terms of normal relationships between price and earnings, it is not particularly necessary to determine with great precision just what its value is. It is sufficient to know that this value is considerably higher than the current market price. Such price-value distortions (investment opportunities) usually occur in periods of general uncertainty, when investor confidence is at a low ebb and vision cannot pierce the clouds that darken the business horizon. At such times, the investor's most important attributes are perspective, based on a knowledge of financial history, and faith in the reasonable assurance that the swings in our economy will continue to pendulate as they always have done in the past. After a long period of rising stock prices, it becomes increasingly difficult to maintain the proper sense of skepticism that should enter into the consideration of any investment opportunity. Rising prices themselves breed optimism, which is apt to turn into confidence that the upward trend will continue. However, the margin of safety that inheres when prices are low narrows and, if prices continue to rise, sooner or later disappears. It is at this point that the investor must make sure that he is not paying too high a price for the future return, measured in both income and expectable capital appreciation, that can be anticipated with reasonable confidence. This is a matter, moreover, that transcends in importance any possible impact on the investor as an individual. Unjustifiably high market prices engender their own correction, and many are financially injured in the subsequent decline in paper values. When this happens to the common stocks of our regulated utilities, there are bound to be repercussions that are unfortunate and unfavorable to continued private enterprise in this field. For this reason, if for no other, the relationship between the market price level and the sound investment value of their company's common stock should be a matter of continuing interest to utility corporate management.

COMMON STOCKS AS INVESTMENTS FOR AMERICAN LIFE INSURANCE COMPANIES, A NON-ACADEMIC VIEW II*

What then is the suitability of common stocks as an additional outlet for policy reserve funds? With current yields on common stocks now running over 5 per cent, backed up by earnings-priPe ratios of almost 12 per cent, compared to yields in debt securities running 3-4 per cent, investments now in this field, on a yield basis, look very attractive. The underlying issue is: are common stocks undervalued compared with other investment outlets? And two other questions are involved: Will common stocks subject the investor to as large capital loss hazards as they have in the past? And what will be the impact on common stock values if long-term interest rates do rise?

Statistical Background of the Crisis of 1857

ECONOMIC surveys of the United States in the pre-Civil-War period never fail to make note of the revulsion of business which came in the year I857. Sometimes this is indicated as the culmination of a speculative movement of considerable, though uncertain, duration. Sometimes it is spoken of as a peculiar, almost quixotic, affair, deriving immediately from the failure of the Ohio Life Insurance and Trust Company, just as the of i837 is alleged to have flowed directly from the single cause of the famous Specie Circular. Again, where such accounts make allowance for speculative activity as forerunner of the debacle of I857, the chief generative element of this speculation is held to have been the enlargement of gold supplies after the discoveries of the mid-century. Yet little has heretofore been accomplished in the scientific appraisal of business conditions in these years, and in particular little has been done in attempting to array together the several aspects of business experience with the object of discovering the various interrelations of these elements. An important exception to the first statement would be W. L. Thorp's Business Annals; but as his study is non-statistical in character, it lacks close comparability with that here undertaken. In the belief that greater realism may be given the crisis of I857 by the procedure just mentioned, certain data on the volume of trade, and on banking and finance, are here joined to those whiclh have been presented elsewhere upon the course of commodity prices, common stock values, and public land sales; and an effort is now made to reveal some of the differences in these several movements.1 THE VOLUME OF TRADE