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When to Buy and When to Sell Equities?

Brian Sturgess - May 2013

1. Introduction 
Investors face the fundamental problem of assessing the value of equities as an investment vehicle. Are equities significantly undervalued offering an opportunity to provide rising future returns? Alternatively, are equities overvalued or fairly valued? There are a number of answers to these questions, but few concrete solutions. This paper aims to categorise the main investment models which have a basis in economics. 

There are three basic approaches for the analysis of the value of the equity market as a whole, rather than the shares of individual companies. This paper aims to explore them from the perspective of their broad conceptual underpinnings, the available evidence and their data requirements. Broadly the three main models to be discussed, which include a number of sub-variants, can be categorised as follows: Shiller’s cyclically Adjusted Price-Earnings model (CAPE), Tobin’s q (QR) and the Equitisation Ratio (ER).


2. CAPE
2.1 Description 
The CAPE (cyclically adjusted price/earnings ratio) measure of the relative value of equities is based on the familiar price earnings (p/e) investment ratio used by analysts as a measure of fundamental value.[1] A p/e ratio is calculated by dividing a company’s current share price by its earnings per share (EPS) or by the ratio of market capitalisation to after-tax earnings. EPS are measured as earnings divided by the...

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