Swedroe: This Metric In Dire Need Of Context

July 14, 2017

Javier Estrada came to the same conclusion in his study, “Multiples, Forecasting, and Asset Allocation,” which was published in the Summer 2015 issue of the Journal of Applied Corporate Finance.

He examined the benefits of using valuations as a tactical asset allocation tool and found that “the evidence does not support the superiority of valuation-based strategies; if anything, it points moderately in the opposite direction.”

Summary

I hope the lessons you take away are: There are logical reasons for valuations to have drifted up; accounting changes and the fall in the propensity to pay dividends make valuations today appear higher than they would otherwise be relative to the long-term historical data; and because there’s so much variation over time in the equity risk premium, there isn’t any methodology that will produce highly accurate forecasts of stock returns—stocks are risky investments no matter the horizon.

That said, we do know that starting valuations clearly matter—and they matter a lot, not just in terms of forward-looking return expectations, but in the dispersion of potential outcomes. Thus, investors should not make the mistake of simply projecting historical returns into the future. And finally, I hope you come away believing that investors are best served by ignoring market forecasts based on opinions and sticking to their well-developed plans, rebalancing along the way.

Larry Swedroe is the director of research for The BAM Alliance, a community of more than 140 independent registered investment advisors throughout the country.

 

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