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The Connections Between Valuation, Risk and Return: The Case for Buying at a Discount

The Connections Between Valuation, Risk and Return: The Case for Buying at a Discount. Berkeley Investment Advisors’ AAII Seminar April 2, 2009. Presented by Ray Meadows MBA, CPA, CFA. Introduction. Why? Low Risk and High After-Tax Real Returns.

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The Connections Between Valuation, Risk and Return: The Case for Buying at a Discount

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  1. The Connections Between Valuation, Risk and Return: The Case for Buying at a Discount Berkeley Investment Advisors’ AAII Seminar April 2, 2009 Presented by Ray Meadows MBA, CPA, CFA

  2. Introduction

  3. Why? Low Risk and HighAfter-Tax Real Returns Sources: Bailard, Biehl, & Kaiser, Institutional Real Estate Inc., “Why Pension Funds Should Invest in Real Estate” 1997 as updated by Rosen Consulting 2000 3

  4. Wall Street Experience + Record 4

  5. Risk Concepts: Volatility Under Standard Academic Efficiency Assumption • Long run volatility is σ * √ T • Annual Volatility of 45% -> 2.8% daily standard dev. • Annual Return of 15% - > .06% daily – 45 times less • But over 5 years: Expected Return = 101% and Standard Deviation = 101% • Ratio of signal to noise drops to 1-1

  6. Drivers of Daily Volatility • Liquidity Trading: Noise Traders • Changes in Required Risk Premiums: I.e. Psyschology and Emotion

  7. Valuation Risk: Overpriced Stocks

  8. Connections Between Valuations and Risk and Return Two determinants of stock returns: A Company’s Returns on Capital: Cash Flows it Generates on it’s Investments How those Cash Flows are Valued by the Market Cash Flows put a Floor on where the Market can go. There is No Ceiling on Over-Valuation 8

  9. Historical Context This is a histogram of month end S&P 500 P/E ratios since 1950 using the average of 10 year trailing earnings as per Gary Shiller’s calculations. The blue bar is the average. The lower histogram shows only the months when the U.S. was in a recession.

  10. Mathematical Treatment

  11. Numerical Example

  12. A Look At Amazon

  13. Place Holder Slide 1

  14. Place Holder Slide 2

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