2020/17 LEM Working Paper Series

Stock Recommendations from Stochastic Discounted Cash Flows

Giulio Bottazzi, Francesco Cordoni, Giulia Livieri and Stefano Marmi
Stochastic Discounted Cash Flow; Asset Valuation; Valuation Uncertainty; Portfolio Strategy.

  JEL Classifications
G11, G17, G32
This paper presents two stocks recommendation systems based on a stochastic characterization of firm present value that extends the conventional discounted cash flow analysis. In the Single-Stock Quantile recommendation system, the market price of a company’s stocks is compared with the estimated distribution of the company fair value to obtain an individual measure of mispricing, while in the Cross-Sectional Quantile system, a relative measure of mispricing is built using the fair value distribution of all firms at the same time. Both systems use mispricing information to build sell side and buy side portfolios. We provide a series of statistical exercises that show how these portfolios can consistently deliver significant excess returns, also when rebalancing costs are accounted for.
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