Edited by Geoffrey Poitras
Chapter 4: Valuing Equities in the UK and the US: Fashions and Trends
Janette Rutterford INTRODUCTION The dot.com boom and bust of the year 2000 made equity valuation a hot topic. How had share prices and intrinsic values got to be so far apart? Was it something to do with the way in which shares were valued? Unable to use book values, as high-tech firms had no tangible assets, with no earnings or dividend track record to go on, analysts turned either to multiples of turnover – they did have sales – or to gazing into a crystal ball and forecasting cash flows. These cash flow forecasts turned out to be on the optimistic side, assuming that each firm in the industry was going to be a winner. When investors realized that not everyone could monopolize market share, the valuation bubble burst. More recently, in the credit crunch, the same thing happened. Analysts, this time bond analysts, thought they had cracked how to value collateralized mortgage obligations (CMOs). Using sophisticated methods – as sophisticated as discounted cash flow seemed in the 1960s – they valued highly complex instruments using complex models which, they tended to forget, had some pretty major assumptions built in. When, for example, the correlation coefficients they had assumed, or the credit ratings they had relied on, proved not to be the right ones, the market prices for CMOs moved very far away from their theoretical values. This chapter looks at how investors have changed the way in which they value shares over time. The four key ways were book value, dividend and earnings...
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