At the moment, one of the most highly voted features in Friends of SGXcafe is “Use various known methods to compute the intrinsic value of stocks”.
As much as I want to do it, it is not easy to compute the real “intrinsic” value of stocks, assuming it even exists. All methods that I have found require subjective opinions of the future. And often, small deviations in assumed values influence the results significantly. One popular way to overcome this is to acknowledge that the computed value would be simply an estimation and introduces some form of “margin of safety” to prevent overestimation. Another major issue is determining when will the market ever reflect this “intrinsic” value in the stock price, assuming it will ever. In a year? 5 years? 10 years? Almost all methods do not even discuss this. This issue makes it difficult to validate any suggested method.
After reading up on various methods for computing intrinsic value and learning about their strengths and weakness, I was inspired to develop “Future Yield”. Instead of computing the elusive intrinsic value, I built a model to predict the amount of dividends one is likely to receive in the next 365 days. And if we divide that with the current price, it would give us the Future Yield.
For example, DBS currently has a predicted Future Yield of 3.0%. What this means is that the model predicts that you are likely to receive dividends of about SGD 0.5679 in the next 365 days, and if you buy DBS at its current price of SGD 18.93, your expected future yield would be 3% (0.5679 / 18.93 = 3%).
Future Yield is computed only for stocks that meet certain criteria. This is to improve the accuracy of the model. That is, it only makes a prediction when it is confident. The model is also tuned to be conservative to prevent overestimation. This also helps to improve accuracy by trading in coverage. (Learn more about accuracy and coverage below.)
The advantages of Future Yield are that it is highly accurate (>90% based on backtest results), it does not require explicit assumptions on the future for each stock individually, and it is a number useful either by itself or when compared with another stock.
You can use it by itself to determine if a given stock is giving you sufficient dividend yield at current price to assume the risks associated with the stock. Or you can use it to compare across several stocks with similar risk profile to determine which is more superior.
The weaknesses of Future Yield are that it can only make predictions for ~10% of all active stocks, and that it tends to underestimate the actual dividends received since it is conservative in order to maintain high accuracy. It does not consider the future capital gain or loss of stocks.
Do you have any thoughts on this new Future Yield? Let me know in the comments or by sending me a message!
The following sections are for users who are interested in the details.
One advantage of Future Yield is that it is easy to validate. Simply compare the prediction made on day X and forward to day X + 365 and check if the collected dividends per share is greater than or equal to the predicted value.
Accuracy: By backtesting with 2014 and 2015 data, Future Yield was able to correctly predict ~91% of the time (i.e. Actual collected dividends is greater or equal to predicted dividends). If we are to become even more conservative and only assume half of what is predicted, the accuracy is ~98% (i.e. Actual collected dividends is greater or equal to half of predicted dividends).
Coverage: The predictions was able to correctly predict ~80% of the actual collected dividends (i.e. Total predicted dividends value is ~80% of the total collected dividends value). It is also able to make prediction on ~10% of active stocks (i.e. It makes predictions on >100 active stocks).
Selection Criteria: Future Yield only makes prediction on stocks that have given out dividends in the last 3 years consecutively, AND has dividend strength >= 75. This is to select stocks that are consistently giving out dividends and have decent fundamentals.
Formulae: Future Yield = Min(Current Yield x Dividend Strength, Median of last 3 year dividend yield) / Latest Close.