Impact of Market Changes and Interest Rates on Four Stocks

Question:   To what extent have the stock prices of four companies – Duke Power, Bank of America, IBM and Proctor and Gamble – moved with the overall stock market?   Do lagged movements in the overall stock market also impact the current period stock price?

How have changes in the 10-year government bond interest rate impacted the stock price for the four companies?

The Data:   The analysis presented here is based on monthly data starting with the fourth month of 1980 and ending with the seventh month of 2018.   N=456.

The Model:   The dependent variable is stock price at period t divided by the stock price at time t-1.   The explanatory variables are S&P 500 at period t divided by S&P at time t-1, three lags of this S&P ratio, and the ratio of the current 10-year government bond interest rate to the lagged 10-year government bond interest rate.

Results:   The results for the return equations for the four companies are presented below.

Duke Power
dukror Coef. P>t
spror 0.33556 0
lag1spror 0.0365767 0.546
lag2spror 0.058777 0.335
lag3spror -0.0211995 0.725
tenyrch -0.1645325 0.001
_cons 0.7624648 0
Bank of America
bacror Coef. P>t
spror 1.392815 0
lag1spror 0.0396445 0.68
lag2spror 0.1671838 0.085
lag3spror -0.0386275 0.686
tenyrch 0.1329733 0.079
_cons -0.6889676 0
ibmror Coef. P>t
spror 0.9212106 0
lag1spror -0.051747 0.444
lag2spror -0.0875875 0.199
lag3spror -0.0776229 0.248
tenyrch 0.0725273 0.172
_cons 0.2299272 0.089
Proctor & Gamble
pgror Coef. P>t
spror 0.5961397 0
lag1spror -0.0131834 0.844
lag2spror 0.0276608 0.682
lag3spror -0.0264788 0.692
tenyrch -0.0543051 0.173
_cons 0.4844197 0


Observations on Beta or Systematic Risk

The short-term beta is the coefficient of the current mark variable.

The long-term beta is the sum of the coefficients for the current market variable and the three lagged market variables.

Below is a chart comparing betas (both short and long term) from this model to betas published by yahoo finance.

Different Measures of Beta
Yahoo Finance Beta One Period Beta from Model Long Term Beta from Model
Duke 0.03 0.336 0.410
BAC 1.67 1.393 1.561
IBM 1.04 0.921 0.704
PG 0.43 0.596 0.584


The order of betas from this model and from Yahoo finance across the four companies least to highest are identical.

Both estimates reveal that Duke Power has the lowest beta and BAC the highest one.

Even though Duke Power still has the lowest beta, the estimates presented here indicate that Duke Power has far larger systematic risk than the Yahoo finance beta estimates.

In two cases, (Duke and BAC) the long-term beta is smaller than the short-term beta. The long-term beta for IBM is lower than the short-term beta.   The long and short term betas for PG are similar.

Need to do more research on reasons difference in companies that might cause this result.

Observations on the Interest Rate Coefficient

The 10-year interest rate is negatively related to stock price for only one company Duke Power.   This coefficient is significantly different from zero for a two-tailed test with alpha equal to 0.05.

The interest rate coefficients for the other three companies are positive but not significantly different from zero at a two-tailed test with alpha equal to 0.05.

Concluding thoughts:   The impact of interest rates on firm returns can be very complicated.  First, the direct impact on the S&P 500 should be modeled.  Changes in short rates could have a much different impact on rates than changes in long rates but this impact could be difficult to separate because of collinearity.

More empirical work on how interest rates impact stock prices will follow.



Is FANG overvalued?

Is FANG Overvalued?

Question:  The hot stock combo right now is FANG (Facebook, Amazon, Netflix and Google.)   What is the PE ratio of a portfolio equally weighted in these four stocks?

Provide an opinion about whether future earnings of prospects for FANG justify this valuation?

Calculation of the FANG PE ratio:

All FANG stocks have positive earning and positive PE ratios so it is appropriate to average PE ratios of the four stocks to obtain the PE ratio for the portfolio.  (I use a weight of 0.250 for each stock and SUMPRODUCT weight vector with PE ratio vector)

PE ratio Dividend EPS Price
Facebook 38.29 0 3.93 150.58
Amazon 183.95 0 5.31 976.78
Netflix 195.38 0 0.77 151.03
Google 31.34 0 29.59 927.33
FANG 112.24

This gives me a PE ratio of 112.24 for FANG.

It is instructive to compare the recent growth of EPS and stock price for the FANG companies

Comparison of growth of EPS and stock price for FANG Stocks
6/29/16 3/30/17 % Change
FB EPS 0.97 1.04 7.2%
Price 114.28 142.05 24.3%
AMZN EPS 1.78 1.48 -16.9%
Price 725.68 886.54 22.2%
NFLIX EPS 0.09 0.4 344.4%
Price 96.67 147.8 52.9%
GOOG EPS 8.42 7.73 -8.2%
Price 699.2 829.56 18.6%

Some Observations:

In three of the four companies the growth of stock prices exceeded the growth of earnings per share.

In two of the four companies, earnings fell while the stock prices rose.

In Netflix, the one company where EPS growth exceeded stock price, the initial period stock price was near zero.   The initial low level of earnings is why the PE ratio of Netflix is going down.   When earnings are near zero the PE ratio can be astronomic.

Concluding thoughts:  Basically FANG stock price is rising because of expectations of future growth not concrete earnings growth.   The one exception Netflix is because of really low earnings in a base period.    Netflix has done a great job but it is in a competitive industry and unlike the other three companies has no monopoly power.

These four companies will face challenges going forward.   The PE of Amazon seems especially high because there is going to be a lot of competition in the cloud sector a lot of costs integrating Whole foods and low margins in the on-line grocery business.

Investors who own FANG should consider taking some profits.

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