tag:blogger.com,1999:blog-8152901575140311047.post2051720493908703907..comments2024-03-19T05:19:06.448-04:00Comments on Musings on Markets: Myth 4.5: DCFs break down with near-zero risk free rates!Aswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comBlogger8125tag:blogger.com,1999:blog-8152901575140311047.post-64771788547768006712016-11-20T10:32:52.374-05:002016-11-20T10:32:52.374-05:00Dear Prof. Damodaran,
I must begin by highlightin...Dear Prof. Damodaran,<br /><br />I must begin by highlighting the importance, impact and usefulness of your role on the 'world of finance' through your books, articles or available data. At least, it has been helping me a lot on my also not so profound thoughts about valuation and macroeconomic issues. <br /><br />Relatively to this post, I do believe/support that relatively low interest rates can be the basis for economic growth as long as financial institutions are able to reasonably evaluate their clients' credit risk and governments/central banks maintain a watchful eye on inflation. Working on the assumption that both premises are guaranteed, low interest rates would release cash outflows for financing activities to investment activities. Additionally, it would force private investors to seek for opportunities within their organizations/companies or look for entrepreneurial endeavours. From my point of view, high interest rates only serve the interests of financial institutions in detriment of real economic growth. <br /><br />To close this argument, I believe that if, in the presence of low interest rates, companies are able to find investment opportunities higher than the cost of capital than value is created both through ROIC and lower cost of capital. However, in the absence of value-creating investments, companies also would be punished by the same reasons (decrease on cash inflows and higher credit risk - spread). It would be interesting to see if your relation between T.Bond rates and GDP growth rate still holds for several individual countries from different regions.<br /><br />At last, with no right to ask something of this kind, I would be overwhelmed if the Professor would have any time or interest in valuing a Portuguese (yes, i'm portuguese) bank named 'NovoBanco' (former Banco Espírito Santo). This historical bank was bailout by the Portuguese government and received €4.9bn. After declining an offer of ~€2bn last year, we are at this moment on a bidding process and rumours talk on a acquisition price less than half of what was offered last year. I confess I would be delighted to hear your thoughts on this company since our country we lack financial discussions regarding some truly impactful issues.<br /><br />Always great reading as much as possible and learning at the same time from Professor.Gonçalo Gomesnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-21261685517670498552016-11-20T06:30:17.238-05:002016-11-20T06:30:17.238-05:00Dear Professor Damodaran,
Thank you for your post...Dear Professor Damodaran,<br /><br />Thank you for your post.<br /><br />It makes perfect sense to adjust ERP in lower growth enviroment.<br /><br />But then, if we try to value fair value of the S&P 500 with a 1,5% risk free rate (4 months ago), even with an ERP of 6,25% and with estimated dividends nominal growth of 4,5% (2,25% real growth + 2,25% inflation) I get a fair PE of 28! Using current 10 year T-bond, 2,35%, I get a fair PE of 24! These are much higher than real current numbers.<br /><br />The point is I think markets are assuming higher ERP but also higher stable LT risk free rates (due to central banks intervention).<br /><br />And this is why I think that again markets can perform well in an increasing rates environment because it is already incorporating that in discount rates (I thing 3,5%-4% for risk free rates).<br /><br />What do you think?<br /><br />Best regards,<br />Hugo RoqueHugo Roquehttps://www.blogger.com/profile/17664911460268836923noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-87029698157478701632016-11-11T06:29:12.048-05:002016-11-11T06:29:12.048-05:00Thanks for the post.
How come you too keep the co...Thanks for the post.<br /><br />How come you too keep the cost of equity constant (rather than making it dynamic)? Sure you use a dynamic ERP as rf rate changes, but it may not change so as to keep Ke constant. <br /><br />Another way to look at this is: When treasury yields 2%, bonds yield a little more, why not settle for say 5% on equities? As an investor I should (so too should other investors) be happy to get say, 5% including dividends from equity compared to the alternative investments available at this point. So shouldn't it be fair to use any rate over treasury and bond yields? Why keep at 8%, just because the implied ERP gives that number? Note that the implied ERP is calculated based on cash flow estimates which can be incorrect too. <br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-81423511795265212932016-11-08T12:22:43.834-05:002016-11-08T12:22:43.834-05:00Quick question professor. Do you think there are ...Quick question professor. Do you think there are special implications for high / low beta companies when rates are near zero? It looks like Cost of Equity is relatively steady ~8%. If a higher percentage of Ke comes from ERP should this drag valuations of higher beta companies, at least theoretically based on CAPM (Ke = Rf + B x ERP). Or is this more theory and practically less likely to actually happen?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-47782296681733094332016-11-08T02:25:24.582-05:002016-11-08T02:25:24.582-05:00Dear Prof. Damodaran,
Thank you for your insightf...Dear Prof. Damodaran,<br /><br />Thank you for your insightful post! The only question I have so far is on which inflation measure you use in your calculations. From the information in your attached file, the inflation rates do not seem to correspond to the DoL average annual inflation rates. <br /><br />Kind regards,<br /><br />TimTimhttps://www.blogger.com/profile/16231184752945989649noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-55635223366556058172016-11-07T10:41:15.367-05:002016-11-07T10:41:15.367-05:00Dear Aswath Damodaran,
Great, that you won't ...Dear Aswath Damodaran,<br /><br />Great, that you won't let go of DCF because of low rates.<br /><br />How come, you estimate, that the real risk free rate should be about the same size as the growth in GDP? (I cannot find the blog where you argue this view)<br /><br />The Fisher Equation is to my knowledge about inflation and the real versus the nominal rate - not about GDP or growth.<br /><br />Also, if you take out inflation from your illustration and compare real rates to real GDP growth they doesn't seem to follow each other very well.<br /><br />Finally, the logic also escapes me. Of course you should demand and expect something (in real terms) for lending out your money - even to a very solid country - but why should it be around the GDP growth rate? <br /><br />Should we really be able to participate in and get the growth of the world without taking any risk?Per Juulnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-74199150284014514372016-11-07T09:44:09.853-05:002016-11-07T09:44:09.853-05:00Can you be more specific on how you calculate ERP?...Can you be more specific on how you calculate ERP? It may be worth a separate post to go over which numbers you use, the logic, etc.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-18335211326856733372016-11-05T06:04:38.690-04:002016-11-05T06:04:38.690-04:00
Hi Ashwath, Great to read your argument. You do a...<br />Hi Ashwath, Great to read your argument. You do a great job of straddling the academic world and the marketplace and that makes you very interesting.<br />You seem to suggest that DCF model that uses “adjusted” assumptions will justify the current valuations. What is the use of a valuation tool in which all parameters can be changed to justify prevailing prices? Doesn’t that defeat the purpose? The utility of a reliable tool is that it provides users with an anchor in reference to which one measures the moving object. If the anchor keeps moving will you ever get valuations that are incorrect? Given the adjusted inputs the market would be fairly valued at all times. <br />Of the two parameters under debate, viz., interest rates and growth rates, the former has a giant market maker (central banker) who steers the rate by providing two way quotes for unlimited quantity, at all times. Therefore we take that as a given. <br />The source of growth rate in the economy is a complex derivative of multiple forces such as demographics, government policies, innovation, competition, technology, politics and many others. Investors attempt to arrive at a growth rate (for an economy or a company) by factoring in these myriad factors. Clearly a complex but not entirely scientific process. The variance in the rate thus arrived is the reason there is a buyer and a seller. <br />To force this complex growth rate down to a number that matches the diktat of central banker is to raise the central banker to the status of God that knows everything there is to know. <br />Venkathttps://www.blogger.com/profile/18245508272896113851noreply@blogger.com