Stock returns and Cash Flows: a new asset pricing approach

In order to determine the value of a stock there are two main strategic approaches; fundamental analysis and technical analysis. Technical analysis attempts to predict the future stocks’ price just looking at the today share’s price movements and at the trading volumes, measured and mainly analyzed with a graphic study approach; tables and plots. This strategy is based on the main concept that all the important fundamental factors are already reflected in the shares’ prices on the market (EMH hypothesis).
Completely different is the concept on which the fundamental analysis is based on. Fundamental analysis is conducted on the belief that the value of a stock is strongly correlated with the performance of the company that issued the stock, with no regard about the market prices. This approach attempts to calculate the future value of a share through different economic variables, known and defined as “fundamentals”. Conducting this type of analysis is not simple because lots of aspects should be considered; the overall performance of the company, the financial statements, profits, assets, revenues and expenses. Everything is done with the aim of performing comparative analysis, for example, by year on year or by certain industry standards, for noticing trends in the financial behavior. Once this has been done, it is possible to evaluate the stock’s price and understand how prices react to the changes in the company’s performance.
Investors usually are focused on market behavior in order to find stocks with the more convenient risk-return payoff. The active investment management of assets is based on try to beat the benchmark index of the market; the shares prices can change despite the true value if the stock is maintained. The returns, in fact, of most of the financial assets, are directly derived from the price at which they are trading on the market. However, investors should analyze all the factors, not only the market prices, that can affect the investments to avoid any not profitable result.
On this purpose, the passive investment management is based on considering the true value of the stock following the “Value investing” approach proposed by Benjamin Graham and David Dodd. The returns are directly derived from the market prices differences, also in this case, but the strategy is mainly based on buying shares at prices lower than the true value or intrinsic value of the stock. Value investors not believing in the EMH hypothesis, try to buy the shares when they are undervalued respect their intrinsic value.