Short Term Expectations in Valuation

Marc Goedhart, Bin Jiang and Tim Koller have an interesting article about valuation in the McKinsey Quarterly. They compare predicted values from a model based on long term fundamentals only to a model incorporating short term investor expectations:

"The behavioral model fits the actual market P/Es better than the fundamental model does, explaining around 90 percent of P/E variability over time, versus 80 percent for the fundamental model. But this result does not mean that the behavioral model is superior. It is better than the fundamental model at describing the market's current P/E level—or its level in the short term. The fundamental model, in contrast, better describes where the market's P/E level should be, so it more accurately predicts market-pricing levels in the longer term."

Timothy Burger
timothyb(at)timothyburger.com