movements thanto selectstocks and thatthesepredictions
canbebasedonfactorsthatareobservable.Whilevaluation
of individual stocks may not be of much direct use to a
markettimer, markettiming strategiescanusevaluationin
one of at least two ways:
1.Theoverallmarketitselfcanbevaluedandcomparedto
the current level.
2.Valuationmodelscanbeusedtovaluealargenumberof
stocks,andtheresultsfromthecrosssectioncanbeusedto
determinewhetherthemarket isover- orundervalued. For
example,asthenumberofstocksthatareovervalued,using
thevaluationmodel,increasesrelativetothenumberthatare
undervalued,theremaybereasontobelievethatthemarketis
overvalued.
Efficient Marketers
Efficientmarketersbelievethatthemarketpriceatanypoint
intimerepresentsthebestestimateofthetruevalueofthe
firm, and that any attempt to exploit perceived market
efficiencieswillcostmorethanitwillmakeinexcessprofits.
Theyassumethatmarketsaggregateinformationquicklyand
accurately, that marginal investors promptly exploit any
inefficiencies,and thatany inefficienciesinthemarket are
causedbyfrictions,suchastransactionscosts,andcannotbe
exploited. For efficient marketers, valuation is a useful
exercisetodeterminewhyastocksellsforthepricethatit
does.Sincetheunderlyingassumptionisthatthemarketprice
is thebest estimate ofthetrue valueof thecompany, the
objective becomes determining what assumptions about