Equity valuation measure - what can they tell us?

Résumé du document

A yield curve is a curve which represents graphically the interest rate of same quality of credit bond related to a precise moment. The point is that those bonds have not the same date of maturity (long-term and short-term rates). The yield curve represents the price of what we can call "the price of liquidity renunciation".

The more the renunciation is on a long period (for an example a long-term bond); the more the interest rate is high. That means that the bond given by companies or states on long period (like 10, 20, or 30 years) must offer higher remuneration than the ones proposed by bank placements or short-term placements (less than one year) to be attractive. In fact, the investor will not get its money back for a long time in the case of long-term bonds, and they may want some advantages not to have this money as liquidity for such a long time.

The difference between bond's interest rates is due to the fact that bonds have different credit risks, liquidity, and taxation. The one which is most used is the treasury dept. It is used as a reference to compare other rates in the market, notably mortgages or banks' ones. It is also used to analyze and anticipate upcoming changes that are going to affect directly the economy.

What is the yield curve and what does it tell us?

Extraits

[...] What is the yield curve and what does it tell us? Yield curve evolutes with a referent long-term rate (state bond for example) and a referent short-term rate on the monetary market. The curve is the spread between those two rates. This spread depends a lot on time, as a 30-year bond is taken in account until its date of payment. The yield curve is a lot analyze because its evolution allows giving an idea of future interests' rate change, inflation and economic evolution. [...]

[...] So as we saw the PER' advantages and inconvenient, let's see now the same thing about the dividend yield. The dividend yield The dividend yield represents the dividend distributed as a percentage of an equity stock value. It is obtain in this way: Dividend yield = Annual dividend per share / Stock's price per share So, as we can see thanks to the formula, it is the annual revenue of equity at a certain time for the investor. This supposed first that the dividend is maintained, which is not always the case. [...]

[...] The inconvenient is that this ratio is not sufficient to know if a value is under or over evaluates, because for example a high drop of an equity stock price could make the yield grows. The Fed Model This valuation measure is quite hard to understand and to explain. The thing we can explain here is that it is based on this principle: on an efficient market, the PER waited for an index composed of a large range of American actions 500) must be the same that the 10-year State bond's yield. Then, if the “equity market” is higher than the bond's one, this model shows that the market is under evaluated. [...]

[...] And if we agree to pay interests, we can use the second one. The fact is, even with using those methods, stakeholders have to stay confident, so have to earn a lot of dividends, because when dividends decrease, confidence decrease too. As we said at the beginning, we don't want to lose our shareholder's confidence and we don't want to be taken over. Nevertheless, if rates are low, funding problem is easy to resolve: we can easily contract a loan to invest and so find a funding solution and pay high dividend for our shareholders, to satisfy them and get their loyalty. [...]

[...] Awaited dividends and final value when equity will be sold must be “actualized” to be estimated at a net present value, to take risks and time in account. Price Earnings Ratio Now, let's study Price Earnings Ratio. This is the more used method of valuation measure because it's one of the easier to manipulate and understand. This ratio helps us to evaluate a company's share price depending on the earnings per share. It helps to answer the question of the shareholder: Do I pay my equity at a high price or not? An investor wants to make a capital gain when he buys a share. [...]