The market risk premium is going down...

It will still be beautiful, it will still be normal... And there are already the first signs.

Duff & Phelps has lowered its recommended Equity Risk Premium for the U.S. market from 6.0% to 5.5% for estimating the cost of capital as of December 9, 2020. The market risk premium is one of the most important parameters necessary to estimate the cost of capital in the Capital Asset Pricing Model (CAPM), used in the processes of valuation of companies and companies.

What factors led D&P to recommend an ERP downgrade?

The most important of them are:

Record level of stock prices on US stock exchanges in the fourth quarter of 2020;
Optimism stemming from the arrival of a COVID-19 vaccine;
Expected further support from the Fed implying a low level of interest rates;
Reduced uncertainty related to the impact of the US presidential election results on the economy and corporate performance.

In addition, US stock price volatility has returned to close to long-term averages, corporate credit spreads have declined to historical averages, consumer confidence and business confidence have improved (albeit still below pre-COVID-19 levels). Of course, there are also risk factors...

To be clear, after the outbreak of the pandemic (25 March 2020) D&P raised its recommended market risk premium from 5.0% to 6.0%. That is, after the reduction, we are halfway to pre-pandemic conditions.

It is also worth noting that the normalized risk-free rate (Rf) is assumed by D&P at 2.5%, which implies a base cost of equity for the US market of 8.0%.

The main question is whether this wave of optimism will also come to Poland...

We recommend

15 tips for perfect preparation of business valuation by comparative approach

The beginning of the year. A time of new resolutions.
In this time of new resolutions, the resolution to perfectly carry out the comparative (market) approach in the process of business valuation fits perfectly. Readers of my note, a little distant from the fascinating issue of business valuation, I inform you that we have three approaches to business valuation:

property (cost),
income-based,
comparative (market).

Valuation of enterprises and companies in times of inflation

High inflation in Poland and around the world affects many areas of economic life. Such examples may be the rising costs of debt of individual governments - a function of the higher yield on government bonds required by investors, or declines on stock markets reflecting the increasing cost of capital resulting from increased macroeconomic risk.

Transaction and valuation. Locked box or completion accounts? Time for a locked box...

The two most common price setting mechanisms in share sales transactions are locked box and completion accounts . Both approaches address the main issue in business sale transactions in a different way - the possibility of adjusting the transaction price due to the time difference between the date of the last financial data of the sold company available to the buyer and the date of the relevant contract (the so-called closing date ). It is common sense to assume that the latest financial data of the subject of the sales transaction are subject to examination by the buyer and then become the basis for negotiations and setting the price on the date of the preliminary contract (so-called signing date ).

EBIT or EBITDA? Or maybe EBIT?

Of course, EBIT . Next, EBITA . Simple and obvious.
But we also have many supporters of EBITDA . But why? The topic is a bit complex - we have the illusory power of EBITDA, the disadvantages of EBIT and a new quality, i.e. EBITA...

Why are P/E and P/BV multipliers passé in company valuation?

I have already written once about the reliability of commonly used P/E and P/BV multipliers... but the questions and comments sent to us encourage us to address the issue again...

Blog

The market risk premium is going down...