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If you have been reading my posts, you know that I have an obsession with equity riskpremiums, which I believe lie at the center of almost every substantive debate in markets and investing. That said, I don't blame you, if are confused not only about how I estimate this premium, but what it measures.
When you augment this price change with the dividends on the index during 2021, the total return on the S&P 500 for 2021 was 28.47%. With equities, the cash flows take the form of dividends and buybacks, and in addition to estimating them using future growth rates, you have to assume that they continue in perpetuity.
The first is the dividends you receive, while you hold stocks, a cash flow stream that provides a measure of stability to investors who seek it. It too requires estimate for inputs, but the range of error is magnitudes smaller than with historical premiums. Actual Returns Your returns on equities come in one of two forms.
To capture the market's mood, I back out the expected return (and equity riskpremium) that investors are pricing in, through an implied equity riskpremium: Put simply, the expected return is an internal rate of return derived from the pricing of stocks, and the expected cash flows from holding them, and is akin to a yield to maturity on bonds.
In a third post on July 1, 2022 , I pointed to inflation as a key culprit in the retreat of risk capital, i.e., capital invested in the riskiest segments of every market, and presented evidence of the impact on riskpremiums (bond default spreads and equity riskpremiums) in markets.
I have also developed a practice in the last decade of spending much of January exploring what the data tells us, and does not tell us, about the investing, financing and dividend choices that companies made during the most recent year. Beta & Risk 1. Dividends and Potential Dividends (FCFE) 1. Equity RiskPremiums 2.
Note that nothing that I have said so far is premised on modern portfolio theory, or any academic view of riskpremiums. It is true that economists have researched risk aversion for centuries and concluded that investors are collectively risk averse, and that the level of risk aversion varies across age groups, income levels and time.
Equity RiskPremium Path : The equity riskpremium of 5.24%, estimated at the start of May 2022, is at the high end of historical equity riskpremiums , but we have seen higher premiums, either in crises (end of 2008, first quarter of 2020) or when inflation has been high (the late 1970s).
Relative Risk Measures Before we embark on how to measure relative risk, where there can be substantial disagreement, let me start with a statement on which there should be agreement. At the start of 2022, the ten sectors (US) with the highest and lowest relative risk (unlettered betas), are shown below.
Exacerbating the pain, corporate default spreads rose during the course of 2022: While default spreads rose across ratings classes, the rise was much more pronounced for the lowest ratings classes, part of a bigger story about risk capital that spilled across markets and asset classes.
Most of the variables that I report are micro variables, relating to company choices on investing, financing and dividend policies, or to data that may be needed to value these companies. I extend my equity riskpremium approach to cover other countries, using sovereign default spreads as my starting point, at this link.
In this post , I argued that one of the key dividing lines between the two groups was flexibility , with companies with more flexible investing, financing and dividend policies winning out over companies with more rigidity on those dimensions. for mature markets.
The macro variables that I track on my site relate to the price of risk, a key input into valuation, in both equity and debt markets: US Equity RiskPremiums : The equity riskpremium is the price of risk in equity markets.
Last week, was my data week, where I download and analyze data on all publicly traded companies, listed anywhere in the world, and I will post extensively on what the numbers look like after a most tumultuous year. As we approach the turn of the calendar year, I have my own set of rituals that prepare me for the new year.
Risk Differences across Countries In this final section, I will look risk differences across countries, both in terms of why risk varies across, as well as how these variations play out as equity riskpremiums.
The Taxation of Investment Income In much of the world, income from investments (interest, dividends) is treated differently than earned income (salary, wages), by the tax code, and the reasons for the divergence are both practical and political: 1.
In the graph below, I look at returns (inclusive of dividends) on the S&P 500 every year from 1928 to 2024. Download historical data Across the 97 years that I have estimated annual returns, stocks have had their ups and downs, delivering positive returns in 71 years and negative returns in the other 26 years.
Thus, as you peruse my historical data on implied equity riskpremiums or PE ratios for the S&P 500 over time, you may be tempted to compute averages and use them in your investment strategies, or use my industry averages for debt ratios and pricing multiples as the target for every company in the peer group, but you should hold back.
In the first five posts, I have looked at the macro numbers that drive global markets, from interest rates to riskpremiums, but it is not my preferred habitat. The second set of inputs are prices of risk, in both the equity and debt markets, with the former measured by equity riskpremiums , and the latter by default spreads.
Thus, my estimates of equity riskpremiums, updated every month, are not designed to make big statements about markets but more to get inputs I need to value companies. In the table below, I show my estimates of the implied equity riskpremium for the S&P 500 at the start of every month, since January 2024, and on March 14, 2025.
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