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 2017 now available. The US risk premium 2017 raised a bit to 6,77% compared to 2016 at 6.25%. In 2015 this risk premium was 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.

Central banks continue trying to control inflation by means of interest rates. So for the moment the US risk-free interest rate remains very low, seen historically. The risk-free interest rate even moved downwards end 2016 to 1,84% from 2,14% end 2015. This means that, together with the 6,77% risk premium, the equity component in company valuation requires a reward of about 8.61% (6,77 + 1,84) currently. Thanks to low interest rates, financial leverage reduces risk premiums. When leverage is still excluded, all this translates into a theoretical PE of 11,61(100 / 8.61). This theoretical PE is currently much lower than the actual PE in the US. For example, on 29-06-2017, the unweighted actual PE for example of the Dow Jones showed a value of 22.

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 actual unleveraged WACC (8.61%), suggests a theoretical PE of 11.6 in 2017. Like in 2007, the real actual PE of 22 almost doubles this value. 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 substantally the theoretical PE. Assuming for example an equity component of 30%, the leveraged WACC would be 3.32 (0,3x6,77 + 0,7x1,84) and thus, conversely, a PE 30,12 (100/3,32), higher than the actual real PE of 22. The buffer of dividend yield (2.06% unweighted) also helps a bit as long as dividend yields remain higher than the risk free rate of 1,84% as indicator of likely financing costs. In 2007, the reverse situation existed with dividend yields of 1,79% and risk free interest at 5,04%. But the question arises if these two buffers remain solid enough to withstand some panic.

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 already fragile. Two factors will increase fragility of the existing buffers or blow them away, turning them into panic factors. On the one hand irrationality, short term players and gamblers tend to drive stock prices further upwards. Financing costs tend to rise in future despite the fear of central banks to cause panic by raising interest rates. Thus, without warranty and subject to calamities, the actual tale of Goldilocks cannot continue forever.

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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