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I would like to hear about the latest research on equity pricing models. How far have we come from the traditional DCF style modelling? Have researchers been able to devise realistic models to predict earnings growth and firm life?Also, do P/E ratios mean revert over periods of stock market boom and bust?.Any links or references would be helpful!Thanks,Vikram.

Any answers??I was wondering what the quant finance folks have to say about valuation of basic securities like equities!

i guess the last thirty or something months did not make the quant-equity-analyst-community feel like they got something. peace

I think focusing on replacement cost is a more fruitful metric...I remember at the height of the equity bubble, the most trenchant comment that I heard was from some septegenarian who'd seen it all many times. He said: 'Are you telling me that if I gave you $50bn in a suitcase, that you couldn't put Yahoo out of business?!'Look at Tobin's Q ratio.For a readable, if slightly populist introduction, read Smithers and Wright's 'Valuing Wall Street'.

I haven't seen anything new on valuation that has made for truly compelling reading. The "latest" was a book called "Expectations Investing: Reading Stock Prices for Better Returns", which I stopped reading after 10 pages and immediately resold on Amazon. I am embarassed to have ever bought it. Damadoran's "The Dark Side of Valuation" is probably one of the better books out in the past few years on the subject. Wilmott touches on stochastic earnings models as a valuation approach - which also makes for interesting reading.

There is some work being done in Real Options. You can divide a firm into the value of its 'assets in place' which generate predictable cashflows, and 'growth options' which tries to value things such as options to expand into the next market, operational options (temporarily shut a plant while the product price is low), etc.In effect this tries to incorporate contingent decision-making into pricing companies. You are then incorporating more information than just the first moment of future cash flows into your valuation.

I just bought "Real Option Analysis" by Mun. Haven't started reading it yet. From the comments on it it looks a better book than Copeland's " Real Options for Practitioners".Any inputs regarding the use of real options in practice?

From what I understand, real option analysis was more or less used to justified the Nasdaq runup.The limitations are abound.But I could be wrong.

Real options (RO) are tough to implement. You don't have much data to model underlying price processes. The markets are not complete so arbitrage arguments don't work well.Nevertheless, the intention is good. RO is really a subset of decision-making under uncertainty. The better you are at evaluating real world assets in the context of:- uncertain environments- ongoing revelation of information- management's ability to adapt their strategies in view of new informationthe better decisions you are going to make.Andrea Gamba has done some work on valuing companies using the Longstaff and Schwartz American option valuation algorithm which is worth a look.

The real options guys will say that the tech boom was a function of the analysts having no substantive valuation methodologies. NPV doesn't work well with no hence valuing clicks etc. The corollary is that real options may have helped by forcing a bit of rigour into their thinking.Pablo Fernandez has written some realistic papers on valuation, including using real options. The papers are compiled in a book called 'Valuation Methods and Shareholder Value Creation'. It's quite good.

Thanks for the heads up, Scotty.I am definitely going to check it out.

To revive an old argument of the Efficient Market crowd, I have recently heard the idea about the markets being "hyper-efficient", in that information that does not make economic sense to dig up is being dug up at a loss by excess analysts and priced into the stock. If you believe that, you can let them do the pricing for you...

exotiqMerton Millar takes the view that equity analysts do discover or put together valuable information (that is, information that gives them a more accurate or more timely price), but that the profits that they make from the additional information equals the costs required to generate the information. And that certainly makes intuitive sense in mature markets.So in hyper-efficient markets anaysts do discover valuable pricing information, but the costs of discovery outweigh the benefits of exploiting the information. Nevertheless, the pricing accuracy and timeliness improves.So you need to convince the analysts to spend their dime in pricing your assets. Worth a thought!