tag:blogger.com,1999:blog-8152901575140311047.post3062286222924535239..comments2020-05-28T09:35:42.963-04:00Comments on Musings on Markets: Dealing with Low Interest rates: Investing and Corporate Finance LessonsAswath Damodaranhttp://www.blogger.com/profile/12021594649672906878noreply@blogger.comBlogger19125tag:blogger.com,1999:blog-8152901575140311047.post-85035500062023146872016-10-17T13:31:18.417-04:002016-10-17T13:31:18.417-04:00Taking the standard DDM: P=D/(r-g). Or Div Yield=r...Taking the standard DDM: P=D/(r-g). Or Div Yield=r-g<br />So, r= Risk Free Rate + ERP<br />If Risk Free Rate= g, then the DDM simply becomes: Div Yield=ERP, (currently at 2%). And most importantly , the Risk Free Rate does not feature in the equity valuation equation at all!<br />I dont think 200 bp is an adequate compensation given that corporate bond spreads are around 100bp to 150bp for inv grade.<br /><br />rs55https://www.blogger.com/profile/18295141329379319099noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-5794500569397838802015-05-12T08:38:54.956-04:002015-05-12T08:38:54.956-04:00Professor,
Another impact from low interest rate...Professor, <br /><br />Another impact from low interest rate is, I think, the lowered cost of M&A deals. That may be indirectly boosting market price more than the interest rate alone indicates. <br /><br />Acquirers like home buyers are looking at the cost of the deal including financing package. The current low rate environment is so attractive as a finance condition for a acquirer that it can inflate price of equity through such indirect low-rate condition. <br /><br />That is even more evident in a private market as the exit price is determined by such deal in which the cost of acquiring equity is judged by the total cost including finance. <br /><br />As you laid out the logic, it seems at present there is a gap between how value should be estimated and what the users of equity deals are looking at. That may be one of the risks of low rate environment we are in now. Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-61307485758887645762015-05-04T13:57:42.050-04:002015-05-04T13:57:42.050-04:00Professor,
I do think the debate over the equity...Professor, <br /><br />I do think the debate over the equity valuation and low interest rate is one of the crucial ones. Anecdotally, Warren Buffet today at CNBC said equities are expensive under the normal rate but it is not at the current rate. <br /><br />From my experience as a professional buy-side equity analyst, when using discount CF model, it has been and is always a big question the way to pick WACC as the past historical trend of long term bond rate is incorporated in it. When rates go lower, assuming everything the same, value of equity goes up. <br /><br />Moreover, as you pointed out, the long term growth rate of excess CF should be adjusted downward accordingly when real interest rate drops, but I have to say equity analysts are unlikely to change it in that way. Anecdotes include NO broker report that says long term growth rate of Apple has been revised down and valuation moves lower because of declining real interest rates. (Well,,, Apple has large net interest income and it is occasionally adjusted by a serious analyst.) <br /><br />What I saw and see it the divergence between real rate and long term growth expectation. Company equity analysts use the terminal growth rate (and ROE) of excess CF at the end of forecast period and links growth rate at the end of forecast (say 5-7 years) with the terminal growth (say 30-50 years from today when the growth reaches equilibrium.) <br /><br />My sense is that the current equity market valuation may be supported by such divergence and even more excessive for private equities and venture business where pensions and university endowments are allocating lots of asset – which I see as a potential and hidden risk. Equity bubble was formed in public market but IMHO this time invisible and under-regulated private and pre-public market may be becoming the stealth bubble driver.<br /> Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-78850584604224305072015-04-30T12:41:20.566-04:002015-04-30T12:41:20.566-04:00Dear Prof. Damodaran,
thanks a lot for the inter...Dear Prof. Damodaran, <br /><br />thanks a lot for the interesting insights on low interest rates.<br /><br />Being a German, however, I am expecting negative 10 year bond interest rates in the next weeks. I wonder what the consequences will be assuming negative eternal growth in the leave alone version of DCF models. <br /><br />Thanks a lot for your answer!<br /><br />Peter HaslerPeter Thilo Haslernoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-82539759009539211772015-04-12T15:25:04.545-04:002015-04-12T15:25:04.545-04:00As always a fantastic post. So far I haven't c...As always a fantastic post. So far I haven't come across anything on this topic that has been so refreshing as your piece. Offering us a new perspective. Thank you. Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-74582570637886880832015-04-11T14:27:03.388-04:002015-04-11T14:27:03.388-04:00Diego,
You have a good point about earnings growth...Diego,<br />You have a good point about earnings growth and the crisis effect. There was a problem, especially during the last 3 months of 2008 and it was not that growth was not adjusting, it was because the cash flows were adjusting more slowly than the market. While I updated the cash flows to reflect monthly changes in buybacks, I am probably over estimating the ERP in the last two months of 2008.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-1082460561900223332015-04-11T14:25:47.567-04:002015-04-11T14:25:47.567-04:00Ray Kumar,
For short periods, the answer is absolu...Ray Kumar,<br />For short periods, the answer is absolutely yes and it has been true for much of the market's history. The earnings growth in companies can be higher than overall economic growth, either because you are coming of depressed earnings or because higher-than-anticipated growth creates an even higher earnings growth.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-68786519193768389162015-04-11T00:51:17.313-04:002015-04-11T00:51:17.313-04:00Note: Re-posting a comment I posted this morning a...Note: Re-posting a comment I posted this morning as appears to be lost!<br /><br />On the matter of “Interest Rate Effect” on the stock market valuation:<br />Is it possible for the expected cash flow growth (of the entire stock market which I assume approximates the performance of economy as a whole) to be much different from the growth of “Nominal” GDP?<br />On an individual company basis - yes, but for the entire market?<br />With your calculation of the 3% or so intrinsic (un-propped) rate (which I suppose means your expectation of a 3% or so nominal GDP growth), would you consider present stock market valuation to be either embedding a slim risk premium or a higher than 3% nominal GDP growth (either more inflation or more real GDP growth)?Anonymoushttps://www.blogger.com/profile/17155806140984982960noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-29583662497095774442015-04-10T10:09:14.447-04:002015-04-10T10:09:14.447-04:00Dear Mr. Damodaran,
As you show, there is a stron...Dear Mr. Damodaran,<br /><br />As you show, there is a strong correlation between long term interest rates and past growth/inflation, but there is limited evidence that a low long term interest rate means low growth in the future. The market is what it is, I agree. Thus the alternative is the actual long term bond investment opportunity today. What is then wrong with leaving the risk free rate alone, but normalize the growth rate? We do know that world GDP growth has been surprisingly stable looking at figures since before 1900.Vidarnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-54695674229364736262015-04-08T18:08:56.060-04:002015-04-08T18:08:56.060-04:00Dear Prof.,
Is there a reason why you don't u...Dear Prof.,<br /><br />Is there a reason why you don't use core inflation to compute the intrinsic rate?<br /><br />Thanks.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-54291801741531334012015-04-08T05:37:33.120-04:002015-04-08T05:37:33.120-04:00Iranian banks are paying 20-22% on 1-year deposits...Iranian banks are paying 20-22% on 1-year deposits. Given the impending deal, the currency is unlikely to collapse much further. And for a foreign person, the high-inflation argument is weak because you will not be spending the money there anyways. Why aren't more non-US persons (who are otherwise subject to US sanctions) depositing money with Iranian banks? Can you get money in or out? The answer is yes, through exchange bureaus. Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-40725010359605592662015-04-06T08:54:21.701-04:002015-04-06T08:54:21.701-04:00Here has an interesting (and also a recently and a...Here has an interesting (and also a recently and actual one) interview with LIAQUAT AHAMED about the power of central banks.<br /><br />Liaquat Ahamed is the author of the book "Lords of Finance: The Bankers Who Broke the World". <br /><br />https://www.youtube.com/watch?v=5qmeLUKqX0g<br /><br />"<i>We discuss the lessons learned and ignored from the powerful central bankers of a century ago. Financial Thought Leader Liaquat Ahamed, the Pulitzer Prize winning author of Lords of Finance discusses the differences and similarities between central bank policies today and those leading up to the Great Depression</i>".<br /><br />Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-76676848171448196402015-04-06T02:48:07.974-04:002015-04-06T02:48:07.974-04:00the fisher equation implies:
real interest rates...the fisher equation implies: <br /><br />real interest rates = nominal interest rates - inflation <br /><br />At the same time, it states that monetary policy has no effect on real interest rates. <br /><br />However, aren't nominal interest rates determined by the demand for money (liquidity preference) and its supply, which is stimulated by the FED? Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-86923195465145704782015-04-05T11:30:40.366-04:002015-04-05T11:30:40.366-04:00The required return on equities is partly a functi...The required return on equities is partly a function of the growth rate assumption. <br /><br />How did your assumed cash flow growth assumption behave post-crisis? I wasn't sure if you used some analyst measure (5yr EPS growth expectations?); a nominal gdp growth rate associated with a lower risk free rate; or just the same assumption as pre-crisis. If you could make that explicit, it would help to better understand how the derived ERP has remained stable.Diegohttps://www.blogger.com/profile/18084671738464414141noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-9991803498463189852015-04-04T08:06:32.445-04:002015-04-04T08:06:32.445-04:00UniverseofRisks,
You are right. There will be a li...UniverseofRisks,<br />You are right. There will be a liquidity impact from a Fed unloading of bonds, but the Chinese government also owns trillions in treasuries. If I had to worry about a destabilizing influence, maybe it is the latter than I should worry about,<br />On real interest rates, here is the way I was taught real interest rates in Econ 101. If you borrow a 100 bushels of wheat today from me, I will let you do so only if you agree to return more than a 100 bushels a year from now. In other words, a real interest rate has to be backed up by real goods and services. Think of it as the rate that would exist even in a currency-free economy.<br />Finally, you are right. My intrinsic interest rate is equal to the nominal GDP in my calculation, but the set up is flexible enough that you can make it richer, by bringing in better estimates of expected inflation and expected real growth.Aswath Damodaranhttps://www.blogger.com/profile/12021594649672906878noreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-29218498684280814182015-04-04T07:24:48.470-04:002015-04-04T07:24:48.470-04:00You say: In the long term, I would argue that a re...You say: In the long term, I would argue that a real interest rate has to be backed up by a real growth rate in the economy. After all, you cannot deliver a 2% real interest rate in an economy growing at only 1% a year in the long term, though you can get short term deviations between the two numbers.<br /><br />I have seen this statement many times. It is not self-evident to me. I would appreciate it if you could provide some kind of demonstration for this statement.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-57572934835314062602015-04-04T03:27:58.975-04:002015-04-04T03:27:58.975-04:00Can you please clarify for me what the distinction...Can you please clarify for me what the distinction between your Intrinsic Interest rate and the Nominal GDP? It looks like it would be the same... Thanks.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-47535738571861210792015-04-03T23:41:38.400-04:002015-04-03T23:41:38.400-04:00The fed has 1.7 trillions dollars of Mortgage back...The fed has 1.7 trillions dollars of Mortgage back securities on its balance sheet as on 31st dec 2014. While its not engaging in QE the fact that its keeping these assets off market must be a stimulus in itself. It must also clearly impact interest rates. So if the feds actions were unwound wouldn't the interest rates shoot up to at least the long term historic rateUniverseofRisksnoreply@blogger.comtag:blogger.com,1999:blog-8152901575140311047.post-68604101809982551132015-04-03T15:43:10.328-04:002015-04-03T15:43:10.328-04:00Hi Mr. Damodaran,
Thank you for the honest remin...Hi Mr. Damodaran, <br /><br />Thank you for the honest reminder about the FED's true power when it comes to hiking interest rates. My question is regarding your november's valuation of lukoil. Are you planning on selling your shares since your updated valuation ( March 2015) presents a vale per share of 42.53 while the current stock is trading at 49.33 (15% premium) ? <br /><br />Thanks <br />Tim Anonymousnoreply@blogger.com