- compare actual earnings
to fair value earnings
where - Yb = yield on A rated corporate bonds
- d = adjustment factor for how analysts value growth (historically 0.1)
LTEG = long term (5 year) earnings growth forecast
actual < fair => market is overvalued
Pros: as compared to fed model, incorporates some equity risk using A rated corp bonds; includes earnings growth
Cons: true equity risk premiums are higher than A rated bonds; earnings estimate can be wrong; assumes constant discount rate; d is a "fudge factor," though there is some correlation to the cycle the market is in