Hi (Colin more than likely!!) I was hoping you could help with with the use of multifactor modelling in active management. I understand how it could be used to generate an expected return estimation. I also see how this could be compared with a market expected return calculated by using the market price in the discounted dividend model in solving for i. What I dont understand is how one can calculate an market implied expected return from a PE ratio model, could you help shed some light on this please? Thanks very much!
Hi I probably can't help much here unfortunately. I was an active manager, but we didn't use multifactor models to helps us. Nor did we use the dividend discount model. The PE ratio is normally just used as a measure of relative expensiveness, and can be used to compare similar stocks (Tesco vs Morrisons). Its not much use for Tesco vs Astrazeneca as they have different growth prospects which will be subjectively assessed. It doesnt allow you to place a theoretical price on a share from scratch. The dividend discount model will allow that with various assumptions. The only thing I have read about using multifactor models here is that you could, in theory, analyse the movements of shares against certain factors (eg currency strengthening, interest rate increases, growth increases, inflation etc). Then as an active manager, decide whether you think the future will be see one or two of those factors happening in the economy. Then select your portfolio such that it comprises shares that will benefit from the movement in the "factors" you have selected. Maybe someone else has an input here.
