Valuing the ASX200 using the Gordon Growth Model - Seems undervalued
Still studying for my CFA Level 2 Exam (rapidly approaching in June) and came across that old friend, The Gordon Growth Model formula. What was new however, is using it to value indexes. So I decided to apply it to the ASX200.
As most of you know, the GGM formula is (Price today) = (Dividend Next Year)/((Rate of Return)-(Growth))
Using RBA figures, we have the average dividend yield over the last 2.5 years as being 4.6%. Applying that to the 1 April value of the ASX200 = 4931 we have a dividend today of 231.80. Assuming a growth rate of 3.25% (OECD forecast), that means next years dividend = 239.33.
Now to our rate of return. Using ASX200 daily returns since November 2010 (the usual 2.5 years), we have an average daily return of 0.0128%. Multiplied by the 256 trading days, we have an yearly return of 3.26%. Add on that dividend yield and we get 7.86% being our total market return.
10 year bond rate average over that same 2.5 yearly period gives us a risk free rate of 4.15%
Using CAPM (with the ASX200 Beta =1) we have a rate of return being 4.15+1* (7.86-4.15) =7.86%
Using g = 0.0325, therefore the ASX value should be 239.33/(7.86-0.0325) = 5183.
Therefore, with April's value of ASX200 being 4931, it appears by this definition that the index is undervalued by around 5%. Could also explain why the index has grown to 5100 today as people start to see the value.
As most of you know, the GGM formula is (Price today) = (Dividend Next Year)/((Rate of Return)-(Growth))
Using RBA figures, we have the average dividend yield over the last 2.5 years as being 4.6%. Applying that to the 1 April value of the ASX200 = 4931 we have a dividend today of 231.80. Assuming a growth rate of 3.25% (OECD forecast), that means next years dividend = 239.33.
Now to our rate of return. Using ASX200 daily returns since November 2010 (the usual 2.5 years), we have an average daily return of 0.0128%. Multiplied by the 256 trading days, we have an yearly return of 3.26%. Add on that dividend yield and we get 7.86% being our total market return.
10 year bond rate average over that same 2.5 yearly period gives us a risk free rate of 4.15%
Using CAPM (with the ASX200 Beta =1) we have a rate of return being 4.15+1* (7.86-4.15) =7.86%
Using g = 0.0325, therefore the ASX value should be 239.33/(7.86-0.0325) = 5183.
Therefore, with April's value of ASX200 being 4931, it appears by this definition that the index is undervalued by around 5%. Could also explain why the index has grown to 5100 today as people start to see the value.
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