I have been reporting industry averages for corporate finance and valuation variables (returns, betas, costs of capital multiples) for a while now: this is my 15th annual update for US companies, and my seventh for European, Japanese and Emerging Market companies. In most years, the changes over the previous year have been marginal, especially for developed market companies. But the 2009 update was very different. Here are some of the highlights:
1. Risk premiums: Both the equity risk premium and default spreads on debt jumped dramatically over the year. The equity risk premium started 2008 at 4,37% and ended the year at 6.43%, its highest value since 1978. The default spreads more than doubled, and in some cases tripled, over the year for every single ratings class; for instance, the spread on a Baa1 rated bond increased from 1.75% to 5.25%. This will have profound effects on valuation. The same company, with earnings, beta and rating unchanged, but with default spreads updated is worth about 40% less today (in intrinsic value terms) than it was a year ago. (One aside. The risk premiums for debt increased more than the risk premiums for equity, which has implications for the mix of financing used by firms).
2. Emerging Market risk: In a crisis, risky asset classes get hit the worst and the country risk premiums for emerging markets have increased for two reasons. One is that the base mature market premium is now higher. The second is that the premium you demand for an emerging market is now higher. For example, the equity risk premium for India has increased from 7% to 11%. The drop in the Sensex should be no surprise.
3. On a multiple basis, everything looks cheap: The sector averages for every multiple - revenue multiples, PE ratios and EV/EBITDA - seem to suggest that we are surrounded by bargains. Before you jump in, a note of caution. The prices are as of January 2009 but accounting numbers lag. The most recent fiscal year for most companies in January 2009 is the 2007 fiscal year. Even trailing 12-month data ends in September. We are scaling post-crisis prices to pre-crisis accounting numbers. Hence, the low multiples. I will do an update in May 2009 and those numbers should contain some of the crisis impact. I am afraid the mismatch will not disappear until the 2010 update.
One final note. I have been asked why I do these data updates and put them on my site. I would love to claim that I am the "Mother Theresa" of finance but I do it for purely selfish reasons. Curiosity drives me to look at the data, and since the tools to convert raw data to accessible data are easily accessible, I bear no cost in sharing what I find with the rest of the world. I hope you find the data useful.
9 comments:
Your comment "We are scaling post-crisis prices to pre-crisis accounting numbers" is a good reminder that we are still half way through this financial crisis with more damage waiting to happen. Amateur investors would do well to remember that even at current prices stocks may not be going cheap in a recessionary environment.
Respected Sir,
Can you also upload some of you video or audio lecture as you have added introductory lesson on Corporate Finance,Valuation,Portfolio
Management and Real Options on Valuation. It would be of great help to we students.
Dear Sir,
I think you are doing the right thing for all students and private investors as they are in much worse position then professionals and someone should put some light on this.
All good thins pay back so your future is bright.
Thanks a lot for posting this data professor Damodaran. I've been using your valuation averages for some time now, and they are of great help for people like me with no access to Bloomberg. Thanks again.
I’m curious of your thoughts CAPM - at least in a practical/empirical sense. It seems to me that the standard way to the observe equity risk premium (i.e., looking at long run stock market returns relative to the “risk free” rate – in reality looking at Ibbotson’s) no longer makes sense as the decline in the index would cause one to observe a lower required equity return (when we all know that equity risk has increased). Am I missing something/are there alternatives to estimate cost of equity that avoid this problem (if it is one)?
Historical risk premiums do not stand for much right now. I do have an extended paper on this on my website and there was an earlier post on the blog on the topic. You can find the paper under research/papers on my site.
I definitely agree that historical risk premiums don't mean much anymore, no more than traffic engineering matters to someone who was run over by a bus.
But at least our historical data tells us where the sidewalk usually is.
Dear Mr.Damodaran,
I agree that at least for a while, projects and valuations could be made with a higher cost of equity and cost of debt, but when we make valuations we have to evaluate until perpetuity and this high cost of capital will decrease again in the future.
Shouldnt we use different kind of rates for the next say 2 years and use a "normalized" rate for the next year on?
or maybe should we use a long term cost of capital to make valautions and put the risks from the current crisis in th cash flows?
Isnt maybe the risk of a world crisis already internalized in the historic risk premium so we dont have to change it every year?
It would be great to have an answer on that questions that haunt me at night when I think about what I should do.
thanks for your incredible books and kind regrads,
Cristóbal Gevert
Chile
Dear prof
Your website is extremely useful. Your gesture is really appreciated (I dont think you have any selfish reasons).
Thanks
Sunil
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