Corporate Finance Partner

Dear ..... ,

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 2019 now finally available. The UK risk premium 2019 lowered substantially to 1,32% compared with 2,87% in 2018. For 2017 the risk premium was 2,45%, in 2016: 1.97%, 2015: 1.91%, 2014: 3.50%, 2013: 1.67, 2012: 1.56% and 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 a bit up to 1,55 end 2018 from 1,50% end 2017. This means that, together with the 1,32% risk premium, the equity component in company valuation requires about 2.87% (1,32% + 1.55%) 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 also 2.87%, or, conversely, a theoretical PE of 34,84. This theoretical PE is currently much higher than the actual PE in the UK. For example the unweighted actual PE of the FTSE 100 showed in 2019 a value between 15 and 17 most of the year, say 16 on average. Same story for the FTSE All Share: on 25-12-2019 23,42.

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%. All this initiated the crisis despite a reassuring theoretical leverage (Equity/(Equity + Debt financed at risk free rate)) of 87,31%.

The actual PE level of 23,42 (All Share) on 25-12-2019 is much lower than this theoretical PE of 34,84. In 2007 the actual PE level was about 5% higher than the theoretical PE. The buffer of dividend yield (3,15% unweighted) is a strong stabilizer as long as dividend yields remain higher than the risk free rate 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%. Theoretical leverage (Equity/(Equity + Debt financed at risk free rate)) is now even far over 100%.

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. Actual real PE is much lower than theoretical PE. Theoretical leverage is now far over 100%. Financing costs remain below dividend income in most situations. Thus, without warranty and subject to calamities, the tale of Goldilocks may well continue for now.

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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