Asset valuation: Comparing long and intermediate term pricing using Supply Side approach (APT), CAPM and Value based metrics
EXECUTIVE SUMMARY
Overview
Investment strategy requires sound capital allocation, asset selection and asset pricing principles and tools to be successful. There are continuous attempts to investigate and improve asset selection strategies, but all of them depend on one fact that the pricing of such asset is right. With ever changing macro economic conditions and due to the impact of globalization asset pricing is not the same it used to be and hence the need to revisit it
Approach
Asset selection and pricing are catch 22 scenarios. You can not price something that is not selected. You can not select something that is not priced. But the classic investment models suggest that diversification makes an investment attractive. Our approach to select an initial asset for study is based on total diversification. The asset in turn is priced using well established asset pricing models and the results are compared and contrasted.
Since empirical analysis is only way to prove something is not a hypothesis, we chose a time horizon in history to evaluate our asset across models. Practical limitations constrained us to select intermediate time horizon of six years for evaluating the models.
Strategy
Our six year time horizon includes significant macro economic changes, firm specific events for many companies. The overall time horizon has a full mix of economic and investment activities enabling us to assert the robustness of our findings. We used APT (Arbitrage pricing theory to study the macro economic impact, Classic CAPM for market risk impact and Economic Value Added model and Free Cash flow model on the companies selec ...