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Financial analysts generally agree that the present value of a firm's future stream of discounted cash flows presents its intrinsic or fair value. If the actual price of a firm's common stock is above or below this intrinsic value, an efficient market will cause the mispricing to quickly disappear. In this study we use Morningstar's Fair Value Price, based on a three phase discounted cash flow model, as a proxy for the true intrinsic value of a firm. The hypothesis we plan to test is that mispricing causes a "revision to the mean" or a price movement toward fair value. Using the 30 stocks in the Dow Jones Industrial Average as our test sample we created a fair value index (FVI) for each stock. (FVIit=FVit/Pit) FVit is the Morningstar fair value price and Pit is the actual stock price for the ith stock at time t. If FVIit>1 we expected the actual price to move up. If FVIit<1 we expected the actual price to fall. Our testing consisted of evaluating the price movements for the Dow Jones Industrial stocks for the years 2009-2012. We evaluated the quarterly returns for each Dow Jones Industrial stock to determine whether the fair value index was an accurate indicator of future returns during the testing period.
Robert D. Dean
Primary Advisor's Department
Davis Center for Portfolio Management
Stander Symposium poster
Alagia, Gianina E. and Thomas, Jessica, "Projecting Stock Price Movements with Fair Value Analysis" (2013). Stander Symposium Posters. 360.