Which Valuation Metric Performs the Best?
Jack Vogel and I have some recent research on one of the more basic questions in finance:
Which valuation metric has historically performed the best?
Here is the abstract of the paper:
We compare the investment performance of portfolios sorted on different valuation measures. EBITDA/TEV has historically been the best performing metric and outperforms many investor favorites such as price-to-earnings, free-cash-flow to total enterprise value, and book-to-market. We also explore the investment potential of long-term valuation ratios, which replace one-year earnings with an average of long-term earnings. In contrast to prior empirical work, we find that long-term ratios add little investment value over standard one-year valuation metrics.
You can download the research at SSRN:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1970693
Our work is preliminary, so feel free to send comments and/or questions.
Please pass this around so we get a broader base of feedback.
Here is a little sampling of the finance porn you are missing:
First, some returns from various ‘normalized’ valuation metrics from 1-year (LTM) to 8-year.
And how about some quintile bins highlighting returns to various valuation metrics?
I understand wanting to simplify the analysis but a more rigorous analysis would adjust for different fiscal year periods by weighting the fundamental data. The main conclusion is to determine the ratio that most accurately reflects financial performance and this is difficult to prove if there is a relationship between fiscal year end and industry since industry can be a proxy for the business model that we are trying to evaluate. Another issue is that the stability of financial ratios for growth firms is far less for trailing ratios than for forward ratios. This may limit your final results to simply finding the most predictive trailing ratio rather than the best relative value metric.