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IBES Valuation Model: Stocks Extremely Undervalued at Trader’s Narrative

No that isn’t a typo, I really do mean undervalued. And extremely is the correct adjective also.

Sometimes a graph just speaks for itself:

IBES valuation model early 2007.png

So what is this graph ?

It comes from the Institutional Brokers’ Estimate System (sometimes written as I/B/E/S) which started in 1976 for US equities and 1987 for international equities. IBES is a huge database that gathers the different estimates of earnings by stock analysts for the majority of U.S. publicly traded companies.

The IBES valuation model compares the 12-month forward estimate earnings yield (earnings/price x 100) of the S&P 500 to the current yield of the 10-year Treasury note.

Lets see how one would have done following its guidance:

  • it got you in at the start of the bull market in the 1980’s
  • it cautioned you just before the crash of 1987
  • it flashed a warning again in late 1991
  • but it was premature as the market dipped only a little bit and went much higher
  • it got you back in in late 1993 which was during the plateau - just before another dramatic liftoff
  • it told you to buy again when the market dipped in late 1995 (fantastic!)
  • it signalled caution in 1997 which resulted in a sideways trading range 2-3 years
  • it repeatedly signalled caution during the bubble years
  • it told you to buy again in mid 2002 - almost the exact bottom of the bear market!
  • it has remained stubbornly flashing a buy signal ever since

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12 Responses to “IBES Valuation Model: Stocks Extremely Undervalued”  

  1. 1 joe rose

    Excellent. Thanks for the info and the effort you put into your blog.

  2. 2 Brian

    Interesting, although I think that the (artificially) low yields we have had for the past few years could be skewing the measure a bit.

  3. 3 Babak

    joe, you’re welcome. :-)

    Brian, possibly but how are the rates “artificial”?

  4. 4 Brian

    In my opinion, mainly through the increasing amount of trade done with a country with a managed currency that is arguably undervalued.

    In recent years, Chinese imports have helped keep the costs of businuesses, consumer goods, and inflation rates low. This has allowed the U.S. economy more room to grow without the need to raise interest rates.

    In other words, I think that the rates in recent years are lower than what they normally would be in the past, when all of the major U.S. trading partners had freely convertible currencies.

  5. 5 Prospectus

    Another factor affecting the equation is huge demand from foreign centrl banks for US Treasurys over the past few years. That has artificially lowered rates (and is linked to the currency valuation mentioned above). When that game unwinds, watch out, world.

  6. 6 Johan

    “it repeatedly signalled caution during the bubble years”

    and that means you just missed like 150% gain in a few years. Have you really looked through this indicator?

    I’m not very impressed.

    But thanks a lot for sharing this info any way!


  7. 7 Babak

    you were expecting it to pinpoint every single top and bottom with 100% accuracy? :-)
    Buffett side stepped the mania and he made out all right. Remember, the most important rule is don’t lose money. Bubbles may be fun but most people lose a lot of money in them. If you avoid the ride up and the ride down, consider yourself lucky!

  8. 8 Doug

    I was looking for information on the q-value when I came across the IBES valuation model, and your site shortly thereafter. It gives me a sense of optimism about the near future of the markets when all I had heard was that the sky was going to fall very soon. Is there a souce of weekly or monthly IBES values/charts? Are you aware of a general rule, i.e. buy at -20 or at when the curve comes back up through the undervalued line? What markets does this take into account, or is it not tied to any? Is there a comparible chart/trend/value for foreign markets? Lots of questions, and I appreciate any assistance you can offer.


  9. 9 Doug

    Is it possible that there is a new equilibrium established? The trend line since mid 2002 seems to be fairly steady. Perhaps market conditions have changed, and the market is now properly valued (or even under/overvalued).

    Just a thought. Do you think there’s any validity?


  10. 10 BAP

    This valuation model depends on analysts’ estimates being right and on the usual cycle of tight/loose money effectively fighting an economic problem. In the past, that has usually worked out pretty well for the model’s predictions. But now, in addition to the conditions skewing the T-bill yield mentioned above, you have a different fighting environment for the Fed and for yields and possibly for earnings estimation. The Fed must now fight, not a normal slowdown in the economy, but an unprecedented proliferation of loose money in the form of CDOs, CDSs, and a host of fiat money credit products and their debilitating effects on the economy. In other words, the Fed this cycle finds that it must fight loose money with loose money. This tosses the past yield cycles out as any kind of guide to what the stock market may do. The markets are efficient enough to weigh all these factors and the inflation implications and not go up just because a model of past yield cycles says that it should.

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