Are Stocks Overvalued? A Survey Of Equity Valuation Models

July 28, 2015

Are Stocks Overvalued

For a larger view, please click on the image above.


Are Stocks Overvalued

For a larger view, please click on the image above.


Are Stocks Overvalued

For a larger view, please click on the image above.

Model 2 is widely known as the dividend growth model. This model is based on the belief that dividend yields are constant over time; that is, equity prices rise in lockstep with cash flows to maintain a constant yield. The second input in the model, historical average real growth, can be neatly estimated using the recent historic trend in real earnings per share (EPS) growth. Long-term real EPS growth in the United States has been relatively constant at about 1.5% a year. Combining this value with the current dividend yield of 2.0% results in a forward one-year expected yield of 3.5%, not dramatically different from the return forecast by Model 1. And like Model 1, the dividend growth model is all but useless over a short time horizon, as is painfully obvious in Figure 2, but it does have merit at longer horizons.

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