Hi In Chapter 22 on page 7 of the notes it says: if the expected return indicated by the multifactor model is lower than that indicated by the current share price the share appears cheap. Is this because if the multi factor model was right, the theoretical share price would be higher than the market price (so that the model's expected return matched what was indicated by the market price). The actual market price is lower than the theoretical and therefore looks cheap? A little counterintuitive so wanted to check. Thank you, Rachael
It is easier to understand this with a few numbers for demonstration. If I design a model of a company, with all the risks etc, and the model comes out with the conclusion that this share should offer an 8% return, then I look at the current market price and it seems likely that it will give me a 4% income yield and a 5% capital gain = 9% total, then the share looks cheap. It is cheap because the expected return from the model is less than the expected return from the market price.
