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Back to fundamentals: The role of expected cash flows in equity valuation

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  • Foerster, Stephen R.
  • Sapp, Stephen G.

Abstract

To better understand how investors have historically valued equities, we compare monthly values of the S&P Index to our corresponding estimated fundamental values from 1871 to 2010, using ex ante available information. We find that the simple Gordon Growth Model performs better than other, more sophisticated valuation models. Based on the Gordon Growth Model, equities were undervalued prior to 1914, overvalued between 1914 and 1981, and fairly valued until 2010 after controlling for well-known economic and price-based factors. We also find the implied market risk premium over this period is around 5%.

Suggested Citation

  • Foerster, Stephen R. & Sapp, Stephen G., 2011. "Back to fundamentals: The role of expected cash flows in equity valuation," The North American Journal of Economics and Finance, Elsevier, vol. 22(3), pages 320-343.
    • Handle: RePEc:eee:ecofin:v:22:y:2011:i:3:p:320-343
    DOI: 10.1016/j.najef.2011.06.001
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    Cited by:

    1. Huang, Ying Sophie & Wang, Yizhong, 2013. "Asset price, risk transfer and economic activities: Firm-level evidence from China," The North American Journal of Economics and Finance, Elsevier, vol. 26(C), pages 663-676.

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    More about this item

    Keywords

    Asset pricing; Valuation; Dividend discount model; Multi-factor models;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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