Reading 17 Example 17:
Solution to 3:
The Fed model, Yardeni model, and CAPE all use some measure of earnings as a determinant of value.
It seems that Fed model does not incorporate earning growth to determine value. Is that a mistake?
No it is not a mistake. It’s called a criticism of the model.
It’s a shortcoming.
Probably not technically a mistake.
It’s a shortcoming of the fed model…
Shortcomings are.
Ignores equity risk premium
Possibility of earnings growth for equity owners
compares real variable to a nominal variable…
Yardeni corrects for this by:
Incorporating using a corporate bond instead of a government bond but still this underestimates ERP
Accounts for LT growth
There should be a nice table in the actual curriculum that summarizes these differences…
Yes, and the Shortcomings of the Yardeni model have to do with corp bond part…
Example 17:
- Which of the models use some measure of earnings as an input? How might this lead to comparison issues?
Solution to 3:
The Fed model, Yardeni model, and CAPE all use some measure of earnings as a determinant of value. Time series comparisons will be problematic if the accounting methods used to determine earnings change over time.
There’s nothing wrong with the answer. Fed model, Yardeni and Cape are all earnings-based relative valuation models. Tobin q and Equity Q are asset based relative models. If accounting rules change over time you can’t compare past periods with current ones.
The input of Fed model is 10 year treasury bond yield. It does not mention earning.
Section 4.1 page 148 Fed model is a theory of equity valuation that the long-term US treasury securities should be equal to the S&P 500 earning yield…
Just look through the equations if you still aren’t clear.
Incomplete. The input is the equity E1/P0 , otherwise known as the earnings yield as compared to the 10 year bond yield.
E1 means earnings.
Future earnings to be more precise. 