One of the topic tests has a question where they ask to determine over/under/fairly valued using the Fed Model.
They give the “justified forward earnings yield” and “forward earnings yield”.
In the answer, “forward earnings yield” is used in the numerator.
1.) Could someone explain the difference? Is justified not E1/P0?
Thanks!
Justified is based on fundamentals not the current market values.
Justified = based on fundamentals + includes growth rate in analysis
Only Yardeni model incorporates growth rate.
No, both FED and Yardeni use forward earnings yield, E1 in numerator. Justified Earnings yield has compounded growth component on current earnings yield, E0(1+g). Yardeni captures earnings growth with weighted LTEG component in denominator.
BTW, I’m talking about numerator and denominator because I calculate 'em as ratios. It is easier.
got it, thanks!
Fed uses forward (market) yield. Yardeni you calculate the justified forward yield, to compare it to the market yield, and conclude whether market is overvalued/undervalued.
Gurifissu - perfect, that’s exactly what I needed to confirm
So is same concept, E1 / P0, for both fed and yardeni, it’s just a labeling issue of calling it justified forward yield for yardeni and just forward yield for fed?
No, it’s not the same concept, to my knowledge. As mentioned, Fed Model compares ACTUAL market forward yield E1/P0 to actual Bond yield YT - therefore if actual market yield is higher, equities are said to be undervalued. Whereas Yardeni model compares JUSTIFIED forward earning yield (using calculations with YB, d, and LTEG) and compares it to ACTUAL market forward yield (presumably same yield in Fed Model) - therefore if Yardeni JUSTIFIED is higher than ACTUAL, equities are overvalued (prices are high). Always use ACTUAL E1/P0 to gauge whether equities are over/under valued - when ACTUAL is higher than either YT (Fed) or JUSTIFIED (Yardeni), equities are undervalued (low prices)
SHoot85 thanks for replying but i just want to be sure — s200magician can you weigh in please? is he still alive?
Both model use E1/P0, FED and Yardeni.
This thread was a very helpful breakdown. I have been making stupid mistakes on these formulas so this was good review.
A great test of this in on the 2013 AM, question 5 (part C and D is this specifically). It is basically this exact question including calculations and justification. with a fun little twist.
Fed uses “Forward Earnings Yield (E1/P0)” and compares to LT govt yield. NOT justified.
Yardeni approximates “Justified Earnings Yield” through the right had of the equation (Yb-d(LTEG)) and compares it to the actual “Forward Earnings Yield (E1/P0)” to see if the current valuation is justified.