Slicing an Asset to Learn about Its Future: A New Perspective on Return and Cash-Flow Forecasting
Slicing an asset by payout horizons unseals information about its future returns and cash flows. As an example, we slice an equity market index into granular pieces (dividend strips) and show that valuation ratios of its strips span the underlying state variables of the index. Strip valuation ratios form a term structure. The level and slope strongly predict the index dividends. The slope alone is sufficient for forecasting the index return. The steepening and flattening of valuation term structure reflect discount-rate variations rather than information on the cash-flow trajectory, because market participants have very limited information about long-term cash flows.
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