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 finally available now. The US risk premium 2019 lowered a bit to a 5,57% level from 6,77% in 2018. In 2017 this risk premium was 6,77%, 2016: 6.25%, 2015: 6,53, in 2014: 6,67%, 2013: 3,80%, 2012: 4,68% and 4.98% for 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. For all other countries look at UK, NL, DE, FR and BE.

Analysis: For the moment the US risk-free interest rate at 2,69% end 2018 remains relatively very low, seen historically. This means that, together with the 5,57% risk premium, the equity component in company valuation requires a reward of about 8.26% (5,57% + 2,69%) currently. Financial leverage reduces risk premiums substantially. When leverage is still excluded, all this translates into a theoretical PE of 12,11 (100 / 8.26). This theoretical PE is currently much lower than the actual PE in the US. The unweighted actual real PE for example of the Dow Jones showed a value of 19,28 on 29-12-2019. Extreme PE-values at or below zero or above 50 are left out to avoid erratic outcomes.

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 US was October 9 2007 when the highest closing price of the Dow Jones was 14.164,53. At March 9 2009 already, the lowest position was reached at 6547,05 and after that day an almost continuous rise of the stock market started. Just before the 2007 crisis, the US risk premium was 6,02%, the risk-free interest rate 5,04% resulting in a unleveraged WACC of 11,06%. See this overview . This level invited investors to pay in 2007 a real DowJones PE of 18,29. This level more than doubled the theoretical 2007 PE of 9,04 (100 / 11.06).

The unleveraged 2019 WACC (8.26%), suggests a theoretical PE of 12,11 in 2019. The real actual PE of 19,28 is now about 60% higher than this theoretical PE, much lower than the 100% last year. Keeping in mind the 2007 lesson that a stock crisis is imminent when real PE exceeds theoretical PE, the questions arises what buffers are left. The buffer of strong leverage certainly helps, thanks to actually much lower interest rates compared to 2007. Strong leverage increases substantially the theoretical PE. But to arrive through leverage at the real actual PE of 19,28, an equity component of 44,82% (equity/equity+loans) is needed. That is a bit higher than actual average gearing giving some kind of buffer. The buffer of dividend yield (2.46% unweighted on Dow Jones) is gone given the risk free rate of 2,69% as indicator of likely financing costs. In 2007, a similar situation but much worse existed with dividend yields of 1,79% and risk free interest at 5,04%. The question how to withstand panic now that one buffer (gearing) is (almost) gone and the other (financing costs) disappeared.

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 that the remaining buffers are fragile or gone. Two factors will increase fragility of the existing buffers or blow them away, turning them into panic factors. On the one hand irrationality when short term players and gamblers stop driving stock prices up and pull them down. On the other hand financing costs appear to stabilize if politics and central banks do not interfere. Thus, without warranty and subject to calamities, the actual tale of Goldilocks is slightly better that last year but unstable.

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.

Best Regards,

Finiconsult Ltd
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