The Fama-French Three Factor Model Case Study

Dick’s Sporting Goods has had reputable equitability consistently throughout the years. Investors have been able to regularly earn a respectable return on their investments. However, some of the valuation metrics of Dick’s Sporting Goods are slightly troublesome. The price to earnings ratio, which is one of the most commonly used gauge of valuing equity securities, has decreased over the last 3 years and recently decreased 24% compared to the previous year, while their earnings per share has increased every year with the exception of the current year where it decreased minimally. This indicates that the market is lessening their expectations of the company. Another commonly used measure is the price to cash flow which eliminates the manipulation that is possible with net income that is used in the price to earnings ratio. This ratio also has decreased recently, thus also indicating a lessening in expectations in the market.

Fama and French’s three factor model attempts to explain the variation of stock prices through a multifactor model that includes a size factor and BE/ME factor in addition to the beta risk factor. Fama-French model essentially extended the CAPM (which breaks up cause of variation of stock price into systematic risk which is non-diversifiable and idiosyncratic risk which is diversifiable) by introducing these two additional factors. Fama and French find that stocks with high beta didn’t have consistently higher returns than stocks with low beta and this indicates that beta was not a useful measure under their model. Their model is based on research findings that sensitivity of movements of the size and BE/ME factor constituted risk, and

The most obvious reason for the difference between the market value of equity and the book value of equity is the inability to record certain intangible assets such as brand value, customer loyalty, and perhaps most importantly, human capital. These intangible assets are likely to provide tremendous earnings growth in the future which determines the company’s market value. Notice also that the company’s choice of conservative accounting policies has the effect of depressing the company’s book value of equity.

Since Berkshire Hathaway is a value investment company I researched the top ratios for value investing and analyzed the last quartet numbers against these ratios. I used key ratios to conduct the analysis which included price to earnings, price to book, debt equity, free cash flow and price/earnings to growth ratio (PEG) (Elmerraji, J. 2009). This information is compiled from the financials making it easy ata a glance to see how the company is performing without going through all the different financial reports such as the Income statement, balance sheet and cash flow statement.

Value investing is a way of investing in company stocks that are considered either undervalued or out-of-favor by the market. In other word, a value investment is one where the intrinsic value of the stock is not accurately reflected in the current market valuation. The underlying reason of too much decreasing in the stock price is that the company may be losing market shares or even in trouble due to market’s panic attributed to negative rumors as well as having management problems. Since the market price

James Baron and David Kreps had given the Five-Factor model, which is based on Michael Porter’s Five Forces model of business analysis (Porter, 1980). These factors will influence the Competitive Intelligence system in any organization. These factors are External Environment, Workforce, Organizational Culture and Structure, Organizational Strategy, and Technology of Production and Organization of Work (Baron & Kreps, 1999). Lack of correspondence between any one of these factors can lead the firm’s CI practices to the failure.

CAPM results can be compared to the best expected rate of return that investor can possibly earn in other investments with similar risks, which is the cost of capital. Under the CAPM, the market portfolio is a well-diversified, efficient portfolio representing the non-diversifiable risk in the economy. Therefore, investments have similar risk if they have the same sensitivity to market risk, as measured by their beta with the market portfolio.

Compared to the market, this value is positive as it means that the company is using more equity than debt to finance themselves.

‘The Capital asset pricing model (CAPM) is a very useful model and it is used widely in the industry even though it is based on very strong assumptions. Discuss in the light of recent developments in the area.’

(a) Fama and French argued that value stocks outperformed growth stocks because they were risker. The outperformance is explained by the excess risk that value stocks face as a result of their higher cost of capital and greater business risk.

In order to test the validity of the CAPM, we have applied the two-step testing procedure for asset pricing model as proposed by Fama and Macbeth (1973) in their seminal paper.

issues will affect corporate values has been debated over the years. This paper will talk about

The analysis of this paper will derive the validity of the Fama and French (FF) model and the efficiency of the Capital Asset Pricing Model (CAPM). The comparison of the Fama and French Model and CAPM (Sharpe, 1964 & Lintner, 1965) uses real time data of stock market to practise its efficacy. The implication of the function in realistic conditions would justify the utility of the CAPM theory. The theory suggests that the expected return demanded by investors on a risky asset depends on the risk-free rate of interest, the expected return on the market portfolio, the variance of the return on the market portfolio, and

Dividend policy theories seek to illustrate the rationale as well as the arguments that have been put forward in relations

Dividend policy remained an issue for many researchers of the finance field. The main question regarding the dividend policy is that whether it is the cause of variability in the prices of the stock or not? this question is still a mystery for the finance related researchers. Dividend can be simply defined as “the residual