It is common knowledge – or at least it should be common knowledge – that value as an investment style works better for stocks that have high uncertainty about the future. If you didn’t know that the explanation is simple. If a stock has very uncertain future earnings or cash flows, there is more room for interpretation both to the upside and downside. This means that there will be a lot of disagreement between investors about the prospects of a stock. If the future then materialises (e.g. when results are published) the uncertainty is reduced and either the most optimistic or the most pessimistic investors have to revise their expectations. That means that either the most optimistic investors have to sell, driving lowering the returns of stocks with a lot of optimistic investors or the most pessimistic investors have to buy, increasing the price of stocks with a lot of pessimistic investors in the shareholder register. In either case, stocks with a lot of optimism priced in start to underperform, and stocks with a lot of pessimism priced start to outperform.
Measuring valuation uncertainty
Measuring valuation uncertainty
Measuring valuation uncertainty
It is common knowledge – or at least it should be common knowledge – that value as an investment style works better for stocks that have high uncertainty about the future. If you didn’t know that the explanation is simple. If a stock has very uncertain future earnings or cash flows, there is more room for interpretation both to the upside and downside. This means that there will be a lot of disagreement between investors about the prospects of a stock. If the future then materialises (e.g. when results are published) the uncertainty is reduced and either the most optimistic or the most pessimistic investors have to revise their expectations. That means that either the most optimistic investors have to sell, driving lowering the returns of stocks with a lot of optimistic investors or the most pessimistic investors have to buy, increasing the price of stocks with a lot of pessimistic investors in the shareholder register. In either case, stocks with a lot of optimism priced in start to underperform, and stocks with a lot of pessimism priced start to outperform.