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Financial Analytics: Science and Experience
 

The assessment of the earnings to stock value ratio in line with inflation

Vol. 14, Iss. 2, JUNE 2021

Received: 1 February 2021

Received in revised form: 15 February 2021

Accepted: 2 March 2021

Available online: 28 May 2021

Subject Heading: FINANCIAL INSTRUMENTS

JEL Classification: C51, E31, G12, G17

Pages: 218–240

https://doi.org/10.24891/fa.14.2.218

Subject. The study discusses the dependence of estimates of the fundamental stock value (based on the earnings-price ratio) on the expected inflation.
Objectives. I determine the type and parameters of such dependence.
Methods. The research is based on methods for estimating the stock value and regression analysis to define the parameters of the suggested model.
Results. For the US stock market (S&P 500 index), it is shown that earnings-price ratio for the earnings averaged over 10 years has a significant positive correlation with the indicator chosen to characterize the expected inflation. It is substantiated that the main reason is the impact of the expected inflation on the real determinants of the fundamental value, primarily on the risk premium. Conditions are formulated under which Gordon's formula can be used to determine the type of relationship between the fundamental stock value and its determinants for a time series of observations with a changing real discount rate.
Conclusions. The model is suggested for estimating the fundamental stock value based on the linear relationship between the earnings-price ratio and inflation., and its parameters are determined. The adequacy of the model is confirmed empirically for the US stock market. The findings can complement investor’s decision-making methods in the stock market.

Keywords: stock market, Earnings-price ratio, Risk premium, Inflation, Stock value, Gordon model

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