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Relative Value Model

The Relative Value Model (RV) is a method of stock market analysis that was developed by Mr. Forster. The concept is to analyse Wall Street’s expectations, and gauge where the market is mispricing assets based on changing expectations.

To accomplish this we plot the price of securities vs the Wall Street consensus earnings estimates, normalized by various measures, such as assets, equity and sales. This gives us the ability to digest a lot of data on expectations, and valuations in a snap shot. Then we overlay our good fundamental judgement, to identify a portfolio that will outperform the market.

Markets are driven by three fundamental forces: Interest Rates, Earnings and Risk.

Interest rates will drive the P/E ratios for stocks. When rates come down, P/E ratios go up, and asset values go up. Under the Greenspan era, the central banking focus was on price stability and we witnessed excellent asset value appreciation. This is the Macro Economic analysis of “systemic risks”. It incorporates such data points as inflation, productivity, trade balances and GDP.
Earnings also impact stock prices. When earnings go up, stock prices go up, and vice versa. This is called “specific risk”. To manage this we look closely at the company management and business model.
Fortrend uses the “Risk Curve Valuation” approach to measuring risk. We look at the range in expectation that Wall Street has for different sectors, and companies. The wider the range in expectations, the greater the uncertainty, the higher the risk, the lower the P/E ratio.

The Relative Value Model is not a financial model that spits out recommendations on technical analysis. Its yardstick requires an overlay of Mr Forster’s personal judgement. No model can replace good judgement and experience. It is Mr Forster’s lifelong commitment to identifying value that makes the Relative Value Model outperform the market so substantially.

Previous Relative Value Model research Reports:

February 2008

March 2009

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