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ValuEngine FAQ

Stock Valuation Model

Why is the Stock Valuation Model superior to traditional equity valuation models such as dividend-discount models, earnings-discount models and cash-flow discount models?

What sets the ValuEngine Valuation Model apart from variants of traditional discount models is a reasonable parameterization of each firm's EPS growth and the economy's interest-rate processes, plus the way in which these parameters are estimated. This is also why our proprietary model performs better than all other equity-valuation models available in identifying truly undervalued, profitable stocks.

Many research studies have demonstrated that the traditional discount models usually do not help much in finding profitable stock opportunities.

Our model valuation not only captures the properly discounted value of a stock's future EPS flow, but also reflects how the market has historically valued the stock in relation to interest rates, and current and expected future EPS. In addition, it takes into account the stock's liquidity and supply demand factors.

What are the fundamental variables used in the Stock Valuation Model?

There are three basic variables utilized in the ValuEngine Stock Valuation Model:

. The most recent, trailing 12-month earnings-per-share information (EPS) of the stock from the day of valuation,
. The most recent forecasted EPS of the company for the future 12-months (based on analyst consensus) from the day of valuation, and
. The current 30-year Treasury yield.

The values of these three variables can change slightly or drastically from day-to-day for any given stock. These changes in the value of any or all of the variables are dependent upon the current and future prospects for the company and the macro economy. Consequently, a stock's model price is subject to change on a daily and intra-day basis.

Are there any other parameters playing a role in determining a stock's model price?

Yes, there are seven firm-specific and three interest-rate parameters that are all determinants of a stock's fair value today, though the importance of each differs across the parameters.

The firm-specific parameters reflect, among other things, its long-term EPS growth, its actual-EPS growth stability, the nature of the firm's business cycle, the volatility or stability of analyst expectations about its future EPS growth, and sensitivity to macroeconomic risk factors. These EPS parameters differ from firm to firm and across business sectors, giving the model ample flexibility to capture each stock's distinct characteristics.

How are the model parameters estimated?

The model parameters for each stock are all estimated from the stock's own history, reflecting not only the business characteristics of the firm, but also the usual supply-demand situation for the stock by market participants. The resulting model price thus captures the firm's fundamental soundness, management effectiveness, and the implicit historical valuation standard of the stock by the market.

How often does a stock's model price change?

Because the values of the three fundamental variables can all change from day to day and intra-day for each stock, each stock's model price is subject to change on a daily and intra-day basis.

What is the relative importance of Earnings Per Share (EPS) growth versus interest rate to model valuation?

In determining an individual stock's fair value, EPS and EPS growth are more important than interest rates.

Is the quality of Earnings Per Share (EPS) estimates critical to determining the model price?

Not necessarily. The ValuEngine Valuation Model automatically adjusts for both accounting irregularities and EPS estimates from companies that are consistently inaccurate. Of course, the better the forecasts about a firm's future EPS, the more accurate the resulting model price for the stock.

I have a stock with very high Price-to-Earnings (P/E) and market/book ratios, but ValuEngine.com says that it is undervalued. Why?

Traditionally, stocks are considered overvalued if they have a high P/E ratio and a high market/book ratio. In this particular case, the stock may be considered "overvalued" in the traditional sense. However, the ValuEngine Valuation Model is based in part on the stock's historical valuation in relation to interest rates and the stock's current and expected EPS. Consequently, if the stock is historically overvalued in the traditional sense, it's possible that once the stock price falls beneath its historic valuation level, it will be considered "undervalued" by the ValuEngine Valuation Model.

My stock has very low Price-to-Earnings (P/E) and market/book ratios, but ValuEngine.com says that it is overvalued. Why?

Traditionally, stocks are considered undervalued if they have a low P/E ratio and low market/book ratio. In this particular case, the stock may be considered "undervalued" in the traditional sense. However, the ValuEngine Valuation Model is based in part on the stock's historical valuation in relation to interest rates and the stock's current and expected EPS. Consequently, if the stock is historically undervalued in the traditional sense, it's possible that once the stock price rises above its historic valuation level, it will be considered "overvalued" by the ValuEngine Valuation Model.

Is the Stock Valuation Model's "model price" based on fundamentals or technical charting?

The ValuEngine model price for a given stock is based on the current fundamentals of both the company and the macro economy. However, the model price can be applied in conjunction with momentum and other relative-strength rankings included on this site.

 

Stock Forecast

What variables are predictors of future returns for a given stock?

Predictive variables fall into three classifications:
(1) Those related to the stock's past performance such as its EPS history, past volatility, and historic risk/return levels,
(2) The company's financial fundamentals, e.g. its balance sheets, cash flow history and operating income statements, and
(3) indicators of the behavior of the overall markets.
ValuEngine's forecasting models employ proprietary formulas that balance these three classifications of data and also take into consideration macroeconomic factors such as the interest rate climate in which the equity markets operate.
The formulas have been derived from the latest academic research.

Are ValuEngine stock forecasts dependent on the ValuEngine Valuation Model?

Not really. Because the model price derived by the valuation model is a current value for a stock, the and the resultant mispricing percentage play a relatively minor role in forecasting future returns. Forecasting relies more on variable criteria like EPS projections, momentum ranking, and Sharpe ratios as well as on a set of econometric models.

Are there different forecasting models for different industries or for different time horizons?

Yes. Each industry has its own forecasting models based on the econometrics peculiar to that industry and which reflect its fundamental characteristics. These models also establish a company's market position across other businesses within its sector. Forecasting models also change as forecasting horizons move out into the future. For shorter time periods, such as 1-12 months, technical variables dominate, while for longer projections out to three years, emphasis shifts to the company's financial fundamentals.

How are the probabilities for a stock's future prospects calculated?

First, all available current and historic data is assembled and plugged into our computer program. Then much as a chess-playing computer considers all possible moves before selecting the best one, our program runs thousands of calculations to create a broad landscape of possibilities. It then narrows its selections to determine the probability of various outcomes, such as a stock returning 20% or more or perhaps doubling in price within a certain time frame and so on, while also calculating the risk of loss during that time.

Are ValuEngine forecasts accurate?

Yes, to the extent that accurate forecasts are possible. Thus far, precise prediction of future events has eluded us. At ValuEngine, however, we have broken new ground in our ongoing effort to isolate, identify, and quantify variables that we have found to influence the rise and fall of stock prices in U.S. and Asian markets. We have tested the interrelationship of these variables and their impact on the value of individual stocks as well as that of whole markets over a fifteen year period. Our research is continuous and aimed at broadening and deepening the scope of our own formulas which strive to reduce the unknowns of stock market behavior. Yet, unforeseen events will always be part of the financial landscape and so risk will always be part of our lives in any marketplace. At ValuEngine.com, we work to reduce it to manageable and acceptable levels and to make our forecasts as accurate as possible.


Portfolio

How is the ValuEngine View portfolio constructed?

The ValuEngine View portfolio is the product of a sophisticated stock valuation model that was first developed by ValuEngine's academic research team. It utilizes a three factor approach: fundamental variables such as a company's trailing 12-month Earnings-Per-Share (EPS), the analyst consensus estimate of the company's future 12-month EPS, and the 30-year Treasury yield are all used to create a more accurate reflection of a company's fair value. A total of eleven additional firm specific variables are also used.

The ValuEngine View portfolio is constructed by integrating this model along with some basic rules for market capitalization and industry diversification. The portfolio has 15 stocks and is balanced once each month. An equal amount of capital is allocated to each stock. The monthly returns are calculated from the closing prices on date of publication.

How is The ValuEngine Forecast 16 Market Neutral Strategy portfolio constructed?

The ValuEngine Forecast 16 MNS portfolio utilizes Forecast Model outputs along with market capitalization, price, and sector diversification rules to provide a monthly portfolio made up of 16 stocks for both the long and short sides.

This model was developed by a team of PhD's and is based on the cutting edge economic theories of Wall Street professionals and Ivy League academics. We carefully examine dozens of fundamental and technical factors for over 8,000 individual stocks, synthesize the data, and then come up with a sector-diverse list of our best and worst forecast 1-month return stocks. Short and long-term historic factors in the VE Forecast model's calculation include past-valuation levels of the stock and its recent price-momentum factor relative to other stocks. Our MNS portfolios have been the best performers during the current market downturn.

This portfolio is published once a month at the beginning of the week near the middle of the month. It can be allocated equally, biased long or short, or utilized as a long or short-only portfolio at user’s discretion. The performance calculation does not include any transaction costs.

Why Market Neutral?

The ValuEngine Forecast 16 Market Neutral Strategy portfolio uses Forecast Model to provide the same sort of long-short equity portfolio utilized by major hedge funds and institutions without the hefty management and performance fees.

Market neutral strategy (MNS) portfolios offer the potential of decent, steady returns in both good markets and bad. For the last three years, the ValuEngine Forecast 16 Model MNS portfolio has provided the highest returns of any of our benchmark portfolio strategies. The ValuEngine Diversified Growth 16 Market Neutral Strategy Newsletter offers the investor capable of running a short side access to increased performance with lower overall volatility and hedged risk. You can run an equally allocated MNS portfolio, or customize it to your needs by adjusting your capital allocation between the long and short sides. With the ValuEngine Diversified Growth 16 Market Neutral Strategy Newsletter, you can--essentially--run your own hedge fund!

Investment Strategy

Should I buy a stock based solely on high-momentum ranking?

No. In fact, basing buy/sell decisions on any one variable is very dangerous. In this case, many stocks with high momentum rankings are also overvalued. As momentum ranking moves up, the overvaluation may move with it with a concomitant increase in risk. This is exactly the sort of trap that the ValuEngine Stock Valuation Model and its Model Price will help you avoid by integrating eleven variables into the valuation process.

Should I buy a stock just because it is undervalued?

Not necessarily. Despite good fundamentals, an undervalued stock can get stuck in that position for a long time, possibly because of human factors within the company or for any number of other reasons. However, undervalued stocks with a good momentum history could well be winners. Also, check the stock's forecast return and Sharpe ratio (the risk/return relationship) as part of your decision making process. Use the whole ValuEngine Stock Valuation Model. That's what it's there for.