Relative Accuracy and Predictive Ability of Direct Valuation Methods, PE Method and a Hybrid Approach

Abstract

In this paper, we assess the relative performance of the direct valuation method and industry multiplier models using 41,435 firm-quarter Value Line observations over an 11-year (1990-2000) period. Results from both pricing-error and return-prediction analyses indicate that direct valuation yields lower percentage pricing errors and greater return prediction ability than the forward price to aggregated forecasted earnings multiplier model. But, a simple hybrid combination of these two methods leads to more accurate intrinsic value estimates, compared to either method used in isolation. It would appear that fundamental analysts could benefit from using one approach as a check on the other.

Keywords: Direct Valuation, PE Multipliers, Hybrid Approach

JEL Classification: M41, G12, G29