Corporate Finance Partner

Dear Madam/Sir ....,

You receive this message because you are interested in company valuation. You bought F-Valuation Software or downloaded a demo version in the past. Herewith the latest news on the risk premium.

Latest Risk Premium 2018 now finally available. The UK risk premium 2018 raised a bit again to 2,87% compared to 2,45% in 2017. For 2016 the risk premium was 1.97%, in 2015: 1.91%, in 2014: 3.50%, in 2013: 1.67, in 2012: 1.56% and still 4.05% in 2011. All calculations are based on the maximum number of years since 1900 and used as method the unweighted average of all methods of calculation.

Analysis:
The UK risk-free interest rate remains very low, seen historically. The risk-free interest rate moved even further downwards to 1,50% end 2017 from 1,56% end 2016, 2.29% end 2015. This means that, together with the 2,87% risk premium, the equity component in company valuation requires about 4.37% (2,87% + 1.50%) currently. Thanks to these very low interest rates, financial leverage reduces risk premiums substantially. When leverage is still excluded, all this translates into a WACC of 4.37%, or, conversely, a theoretical PE of 22,88. This theoretical PE is currently much higher than the actual PE in the UK. For example, on 26-10-2018, the unweighted actual PE of the FTSE 100 showed a value of 15,44, much lower than the 21,40 of last year. Same story for the FTSA All Share: on 26-10-2018 19,74 compared to 23,75 last year. Erratic outcomes are avoided in these calculations by excluding PE's over 100% or below 0% to avoid the CAPE method.

Compare:
History shows that turning points on the stock market only start if the real PE becomes much higher than the theoretical PE. The last turning point in the UK was November 10 2007 when the highest closing price of the FTSE100 was 6,724.54. At March 3 2009 already, the lowest position was reached at 3,512.09. After that an almost continuous rise of the stock market started. Just before the 2007 crisis, the UK risk premium was 2,94%, the risk-free interest rate 4,54% resulting in a unleveraged WACC of 7,48%. See this overview . This level invited investors to pay in 2007 a real FTSE30 PE of 14,07 with a dividend return of 3,27%. This level exceeded the theoretical 2007 PE of 13,37 (100 / 7,48) with about 5%. That level implied also a leverage (Equity/(Equity + Debt financed at risk free rate)) of 87,31%. The actual risk premium, currently around 2,87%, the risk-free interest rate ( 1,50%) and the WACC (4.37%), suggests a theoretical PE of 22.9 in 2018. Actual PE levels of 15,44 (FTSE 100) and 19,74 (All Share) are 33%(FTSE 100) or 14% (All Share) lower than the theoretical PE of 22,88. In 2007 actual PE level was about 5% higher than the theoretical PE. It is true that the downfall of all share prices in recent months contributed a lot to this conclusion. But the buffer of dividend yield (3,93% unweighted) is a strong stabilizer as long as dividend yields remain higher than the risk free rate of 1,5% as indicator of likely financing costs. In 2007, the reverse situation existed with dividend yield of 3,27% and the risk free interest rate 4,51%.

Predict: It is good tradition in this bulletin to leave now the field of facts and figures to enter the world of gurus and prophets. The usual market irrationality, as reported on the 2006/2007 basis, suggests a stable situation after the recent downfall of share prices. Actual real PE is much lower than theoretical PE. Leverage defined as Equity/(Equity + Debt financed at the risk free rate)) in 2007 of 87,31% is far below the actual leverage of >100%. Financing costs remain below dividend income in most situations. Thus, without warranty and subject to calamities, contrary to some warning last year, the tale of Goldilocks may well resume.

A free valuation demo can be downloaded from this website by clicking on the link: Free Software. The latest version 8 with the latest risk premiums can be purchased online with the link: Order Software.

Kind Regards, Finiconsult Ltd
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