Lately, I have been reading a bit on this equity valuation methodology called Residual Income due to my studying for CFA. In summary, Residual Income method purports the following:
Share Price = NBV + NBV * (ROE - r)/(r - g)
where
NBV = Net book value
ROE = Return on Equity
r = Required Return on Equity
g = Expected Growth Rate
In my opinion, assuming that most of the information are captured in the financials already, then this method really comes closest to identifying undervalued stocks. It not only captures the future earnings prospects for the same stock, much like what P/E multiplier does, but also captures the NBV effect, an important and not to be neglected aspect.
Previously, I merely relied on P/E and separately reviewed stocks with decent NBV, but it was not "scientific" enough, in the sense that I could not properly apportion the weights between the two components. Residual Income simplifies that for me. Importantly, it is also empirically shown that the method itself is rather reliable at predicting share prices.
Based on this, I compiled the following list of undervalued stocks. I also read up on each of these companies to be certain that there were no good reason behind their undervaluation, or at least not that I know of.
In 6 months' time, I will review this list to confirm empirically if indeed this has been an efficient way of identifying undervalued stocks.
