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Description

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.

Publication Date

4-17-2013

Project Designation

Independent Research

Primary Advisor

Robert D. Dean

Primary Advisor's Department

Davis Center for Portfolio Management

Keywords

Stander Symposium poster

Projecting Stock Price Movements with Fair Value Analysis

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