Murdering Mr. Market: An Equity Valuation and Capital Allocation Model for Long-Term Value-Investors

Abstract

We present an equity valuation model that is in the spirit of the long-term value-investors Benjamin Graham and Warren Buffett. Taking a longer term view of business prospects and business risks, we explicitly consider Schumpeter’s forces of creative destruction as the central tenet of our model and capture its effect in a probabilistic manner. Assuming that our investor has log utility, we show that our valuation model answers the question of how much capital to allocate. Unlike CAPM, our model does not enforce the Efficient Market Hypothesis and qualitatively explains some well-known empirical studies on stock returns in existing literature.