My Twitter

  • Subscribe to our RSS feed.
  • Twitter
  • StumbleUpon
  • Reddit
  • Facebook
  • Digg

Monday, 2 February 2009

Low riskfree rates...

Posted on 12:27 by Unknown
One of the many perils of valuing a company in the US or Europe right now is that the riskfree rates in US dollars and Euros are at unprecedented lows - about 2.3% in US $ and about 2.8% in Euros. Analysts, confronted with these riskfree rates, are faced with a quandary. If they use the low riskfree rates, they end up with low discount rates which then result in high valuations. To get around this problem, many are asking the question: Are riskfree rates too low and should we replace them with higher normalized rates (perhaps average rates over time)? Good question, but the wrong place to ask it...

Let me take a step back. It is true that riskfree rates are low but they are not the only numbers at unusual levels. Equity risk premiums and default spreads are at historical highs and the worry about global economic growth is deeper than at time in recent history. When we use low riskfree rates in valuation, we have to accompany them with much higher risk premiums than we would have used a few months ago, lower real growth and lower expected inflation. The net effect is that intrinsic values are lower now than they were a few months ago. 

What gets analysts into trouble is inconsistency. If we use today's riskfree rates and stick with risk premiums that we used to use in the past and growth rates and inflation rates that are also from the past, we will over value companies. The culprit is not the low riskfree rates but internal inconsistency. 

My advice is that you stay with today's riskfree rates but update the other numbers you use in valuation to reflect the environment we face right now. If you insist on replacing today's riskfree rate with your normalized number, you should then adjust all your other numbers to be consistent - not easy to do, in my view. 

Finally, I have a paper on riskfree rates that you may find useful (or not). You can find it by clicking on this link.
I hope you find it useful.


Email ThisBlogThis!Share to XShare to Facebook
Posted in | No comments
Newer Post Older Post Home

0 comments:

Post a Comment

Subscribe to: Post Comments (Atom)

Popular Posts

  • Equity Risk Premiums and the Fear of Catastrophe
    As many of you already know, I am a little fixated on the equity risk premium. More than any variable, it explains what happens in equity ma...
  • Love the company! Love the product! Love the stock? An Update on Apple
    My first computer was a Mac 128K . I was a budget-constrained doctoral student from UCLA, teaching my very first class at UC Berkeley. At $2...
  • Hard wired to deceive?
    As the Madoff story runs its course and investors express surprise and shock that they were taken to the cleaners, it may be worth noting th...
  • Cash and Cross holdings
    I am sorry about the long break between posts but I was on the road for much of the last two weeks and grading exams prior to that. I starte...
  • Many a slip between the cup & the lip: From forward value to value per share today
    Valuing young, growth companies is never easy to do but it is well worth doing, partly because it forces you think through the business that...
  • Emotions, Intrinsic value and Dividend Clienteles: The Apple trade postscript
    Now that I have read some of the reactions to my post on "folding" on Apple, I would like to respond to at least three issues that...
  • Twitter announces IPO: The Valuation
    A little more than a week ago, I posted my first take on Twitter and argued that even in the absence of financial information from the comp...
  • Transactions Costs and Beating the Market
    One of my books, Investment Fables , is directed at answering one of the most puzzling questions in investments: How is that there seem to b...
  • Time to Split!!
    As many of you are probably aware, Berkshire Hathaway has announced its intent to split its class B shares and the requisite "deep anal...
  • Hundred dollar bills are hard to come by!
    It looks like I just I cannot stay away from the Apple story, with Tim Cook making a splash (or a belly flop) with his speech in New York ye...

Categories

  • Acquisitions
  • Corporate Governance
  • Data Observations
  • Dividends and cash balances
  • Equity Risk Premiums
  • Facebook
  • Facebook IPO
  • Governments and value
  • I
  • Information
  • Introduction to web site
  • Investment Philosophy
  • IPO
  • liquidity
  • prices and value
  • Private Equity
  • Taxes and value
  • Teaching
  • The
  • Value and Pricing
  • Value Investing
  • Value of a franchise
  • Value of growth
  • Year end

Blog Archive

  • ►  2013 (36)
    • ►  November (2)
    • ►  October (7)
    • ►  September (7)
    • ►  August (1)
    • ►  July (4)
    • ►  June (2)
    • ►  May (1)
    • ►  April (2)
    • ►  March (2)
    • ►  February (5)
    • ►  January (3)
  • ►  2012 (49)
    • ►  December (8)
    • ►  November (3)
    • ►  October (4)
    • ►  September (3)
    • ►  August (3)
    • ►  July (2)
    • ►  June (5)
    • ►  May (5)
    • ►  April (6)
    • ►  March (3)
    • ►  February (3)
    • ►  January (4)
  • ►  2011 (55)
    • ►  December (3)
    • ►  November (3)
    • ►  October (5)
    • ►  September (6)
    • ►  August (4)
    • ►  July (3)
    • ►  June (3)
    • ►  May (4)
    • ►  April (7)
    • ►  March (5)
    • ►  February (6)
    • ►  January (6)
  • ►  2010 (45)
    • ►  December (5)
    • ►  November (6)
    • ►  October (4)
    • ►  September (6)
    • ►  July (1)
    • ►  June (4)
    • ►  May (2)
    • ►  April (3)
    • ►  March (5)
    • ►  February (4)
    • ►  January (5)
  • ▼  2009 (60)
    • ►  December (3)
    • ►  November (6)
    • ►  October (5)
    • ►  September (6)
    • ►  August (3)
    • ►  July (3)
    • ►  June (4)
    • ►  May (4)
    • ►  April (5)
    • ►  March (9)
    • ▼  February (7)
      • Fama-French and the Proxy Wars
      • Can betas be negative? (and other well used interv...
      • Alternatives to Regression Betas
      • The problem with regression betas
      • What betas can... and cannot do...
      • Executive Compensation Caps
      • Low riskfree rates...
    • ►  January (5)
  • ►  2008 (42)
    • ►  December (6)
    • ►  November (8)
    • ►  October (13)
    • ►  September (15)
Powered by Blogger.

About Me

Unknown
View my complete profile