thequestionofhowhighanR-squaredhastobetobe
meaningful,wewouldfocusonthepredictivepower
oftheregression.WhentheR-squareddecreases,the
ranges on the forecasts from the regression will
increase. As an example, the beverage sector
regression(fromIllustration7.2)yieldsaforecasted
P/Eof32.97forCoca-ColabuttheR-squaredof 51
percentgenerates arangeof27.11to38.83forthe
forecastwith 95 percentaccuracy;iftheR-squared
had been higher the range would have been tighter.RECONCILING RELATIVEAND DISCOUNTED CASH
FLOW VALUATIONS
The two approaches to valuation—discounted cash flow
valuation and relative valuation—will generally yield
different estimatesof valuefor thesamefirmat thesame
pointintime.Itisevenpossibleforoneapproachtogenerate
the result that the stock is undervalued while the other
concludes that it is overvalued. Furthermore, even within
relative valuation, we can arrive at different estimates of
valuedependingonwhichmultipleweuseandwhatfirmswe
based the relative valuation on.
The differences in value between discounted cash flow
valuationandrelativevaluationcomefromdifferentviewsof
marketefficiency,orputmoreprecisely,marketinefficiency.
Indiscountedcash flowvaluation,weassumethat markets
make mistakes,that theycorrect thesemistakesover time,
andthatthesemistakescanoftenoccuracrossentiresectors
oreventheentiremarket.Inrelativevaluation,weassume
thatwhilemarketsmakemistakesonindividualstocks,they
arecorrectonaverage.Inotherwords,whenwevalueanew