Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-1

-

Pric

e to

Val

ue:

An

Alte

rnat

ive

Valu

atio

n A

ppro

ach

to S

tock

Sel

ectio

n

A P

rese

ntat

ion

at N

orth

field

Ann

ual R

esea

rch

Con

fere

nce

Lin

da H

. Zha

ng

Dec

embe

r 4,

2000

Bar

ing

Ass

et M

anag

emen

t 12

5 H

igh

Stre

etB

osto

n, M

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(617

) 946

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4lin

da.z

hang

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ring-

asse

t.com

Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-2

-

Pres

enta

tion

Out

line

Wha

t has

mot

ivat

edth

is st

udy?

How

doe

s PV

com

pare

with

trad

ition

al v

alua

tion

mod

els?

Wou

ld P

V h

ave

been

mor

e ef

fect

ive

stoc

k se

lect

ion

tool

?

How

can

one

use

this

mod

el a

s a si

gnal

for f

allin

g an

gels

?

Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-3

-

Stru

ctur

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hang

e in

Mar

ket C

ompo

sitio

n I.

Mot

ivat

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Stru

ctur

al c

hang

es in

the

mar

ket c

ompo

sitio

n ha

s m

ade

the

trad

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al v

alue

mod

els l

ess r

elev

ant.

US

Mar

ket -

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or S

ecto

r Wei

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212

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Basi

c M

ater

ials

7.6

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5.5

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1.6

Cap

ital G

oods

11.1

9.1

8.4

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7.3

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Com

mun

icat

ion

Serv

ices

6.1

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Con

sum

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tock

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sel 1

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ere

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aptu

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ost l

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sec

tor t

hem

e.

Mem

ber o

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riso

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ss m

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l.

74

4744

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ConsumerStaples

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a as

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Mem

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Tech

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Mem

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Nor

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0102030405060708090100

110

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pres

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Mem

ber o

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f Top

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05101520253035404550

010

2030

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k)

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and

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rate

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exp

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Mem

ber o

f IN

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PB

PE

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tron

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tock

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ctio

n si

gnal

s tha

n tr

aditi

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ratio

s.

PV g

ave

no si

gnal

s in

1999

, whi

le o

ther

mod

els g

ave

wro

ng si

gnal

s.

Mem

ber o

f IN

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roup

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thfie

ld C

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1-

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ualiz

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s R

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1988

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Effe

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s

Qui

ntile

Exc

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Retu

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ver U

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1E

Q2

EQ

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Q4

EQ

5

PV h

as b

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mor

e ef

fect

ive

in d

iffer

entia

ting

the

good

from

the

bad.

Mem

ber o

f IN

G G

roup

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thfie

ld C

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renc

e 20

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sO

ther

Con

side

ratio

ns

Tim

e ho

rizon

bef

ore

term

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val

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omes

in.

Estim

atin

g im

plie

d co

st o

f cap

ital

Gro

up a

vera

ge v

s. fa

ctor

adj

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d ap

proa

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Sect

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vera

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s. in

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vera

ge

Mem

ber o

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Nor

thfie

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igna

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isto

rical

Impl

ied

Cos

t of C

apita

l

Ave

rage

198

8-20

0003

/31/

2000

Cha

nge

Tech

nolo

gy5.

701.

72-3.98

Cap

ital G

oods

5.52

2.41

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sum

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4.73

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mun

icat

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Ser

v5.

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rgy

4.65

3.83

-0.82

Con

sum

er S

tapl

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025.

081.06

Hea

lth C

are

3.76

5.44

1.69

Bas

ic M

ater

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8.96

11.0

12.05

Tran

spor

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9512

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Fina

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ls13

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21.2

88.00

All

com

pany

6.61

6.07

-0.54

Impl

ied

CoC

is th

e di

scou

nt ra

te, w

hich

equ

ates

the

futu

re

resi

dual

inco

me

to th

e ob

serv

ed m

arke

t pri

ce.

It re

flect

s the

mar

ket c

onse

nsus

of

a fir

m’s

cos

t of c

apita

l.

Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-1

4-

IV. C

oC S

igna

lC

hang

e in

Cos

t of C

apita

l Ove

r Tim

e

Impl

ied

CoC

dro

pped

to a

his

tori

cally

low

leve

l in

Mar

ch 2

000,

som

e fir

ms’

CoC

eve

n be

cam

e ne

gativ

e.

Doe

s abn

orm

ally

low

CoC

sign

al a

nyth

ing?

0.0

2.0

4.0

6.0

8.0

10.0

12.0

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

Implied Cost of Capital %

All c

ompa

nyTe

chno

logy

CIS

CO

Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-1

5-

IV. C

oC S

igna

lPe

riodi

c R

etur

ns b

y Q

uint

ile o

f Im

plie

d C

OC

A

sto

ry s

ince

Mar

ch 2

000

-40

-30

-20

-1001020

Qui

ntile

I(h

ighe

st IR

R)

Qui

ntile

II

Qui

ntile

III

Qui

ntile

IVQ

uint

ile V

(low

est I

RR

)

Periodic Return in %

1mth

2mth

3mth

7mth

(10/

31/0

0)

The

stoc

ks w

ith a

bnor

mal

ly lo

w im

plie

d C

oC m

ay sp

ell t

roub

le.

Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-1

6-

CoC

at E

xtre

mes

vs.

Sub

sequ

ent P

erfo

rman

ceA

sto

ry s

ince

Mar

ch 2

000

IV. C

oC S

igna

l

-70

-60

-50

-40

-30

-20

-100102030

CO

C(>

20)

CO

C (>

3)C

OC

(2-3

)C

OC

(0-2

)C

OC

nega

tive

Return in %

1mth

2mth

3mth

7mth

(10/

31/0

0)

Extremely

Undervalued

Signal

Trouble

Impl

ied

CoC

bel

ow 2

app

ears

to si

gnal

trou

ble.

CoC

abo

ve 2

0 m

ay si

gnal

incr

edib

le b

arga

in.

Mem

ber o

f IN

G G

roup

Nor

thfie

ld C

onfe

renc

e 20

00-1

7-

Con

clus

ion

Pric

e va

lue

is a

nat

ural

pro

gres

sion

over

trad

ition

al

valu

atio

n ra

tios.

PV m

akes

cro

ssin

dustr

yan

d cr

oss m

arke

t com

paris

on m

ore

mea

ning

ful.

This

mod

el fr

amew

ork

has t

wo a

pplic

atio

ns.

The

first

one

is

to u

se it

as a

stoc

k se

lect

ion

tool

.

The

seco

nd a

pplic

atio

n is

that

one

can

use

this

mod

el to

infe

r th

e im

plie

d di

scou

nt ra

te (C

oC);

and

then

use

this

rate

as a

sig

nalli

ng to

olfo

r fal

ling

ange

ls.