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ChoosingtheParameters:Disney
¨ Periodused:5years¨ ReturnInterval=Monthly¨ MarketIndex:S&P500Index.¨ Forinstance,tocalculatereturnsonDisneyinDecember2009,
¤ PriceforDisneyatendofNovember2009=$30.22¤ PriceforDisneyatendofDecember2009=$32.25¤ Dividendsduringmonth=$0.35(Itwasanex-dividendmonth)¤ Return=($32.25-$30.22+$0.35)/$30.22=7.88%
¨ ToesUmatereturnsontheindexinthesamemonth¤ IndexlevelatendofNovember2009=1095.63¤ IndexlevelatendofDecember2009=1115.10¤ DividendsonindexinDecember2009=1.683¤ Return=(1115.1–1095.63+1.683)/1095.63=1.78%
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Disney’sHistoricalBeta
!ReturnonDisney=.0071+1.2517ReturnonMarketR²=0.73386
(0.10)
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AnalyzingDisney’sPerformance
¨ Intercept=0.712%¤ Thisisaninterceptbasedonmonthlyreturns.Thus,ithastobe
comparedtoamonthlyriskfreerate.¤ Between2008and2013
n AverageAnnualizedT.Billrate=0.50%n MonthlyRiskfreeRate=0.5%/12=0.042%n RiskfreeRate(1-Beta)=0.042%(1-1.252)=-.0105%
¨ TheComparisonisthenbetween¤ Intercept versus RiskfreeRate(1-Beta)¤ 0.712% versus 0.0105%¤ Jensen’sAlpha=0.712%-(-0.0105)%=0.723%
¨ Disneydid0.723%beaerthanexpected,permonth,betweenOctober2008andSeptember2013¤ Annualized,Disney’sannualexcessreturn=(1.00723)12-1=9.02%
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MoreonJensen’sAlpha
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¨ Ifyoudidthisanalysisoneverystocklistedonanexchange,whatwouldtheaverageJensen’salphabeacrossallstocks?a. Dependuponwhetherthemarketwentupordownduringtheperiodb. Shouldbezeroc. Shouldbegreaterthanzero,becausestockstendtogoupmoreodenthandown.
¨ DisneyhasaposiUveJensen’salphaof9.02%ayearbetween2008and2013.Thiscanbeviewedasasignthatmanagementinthefirmdidagoodjob,managingthefirmduringtheperiod.a. Trueb. False
¨ DisneyhashadaposiUveJensen’salphabetween2008and2013.Ifyouwereaninvestorinearly2014,lookingatthestock,youwouldviewthisasasignthatthestockwillbea:a. Goodinvestmentforthefutureb. Badinvestmentforthefuturec. NoinformaUonaboutthefuture
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EsUmaUngDisney’sBeta
¨ SlopeoftheRegressionof1.25isthebeta¨ RegressionparametersarealwaysesUmatedwitherror.TheerroriscapturedinthestandarderrorofthebetaesUmate,whichinthecaseofDisneyis0.10.
¨ AssumethatIaskedyouwhatDisney’struebetais,aderthisregression.¤ WhatisyourbestpointesUmate?
¤ Whatrangewouldyougiveme,with67%confidence?
¤ Whatrangewouldyougiveme,with95%confidence?
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TheDirtySecretof“StandardError”
Distribution of Standard Errors: Beta Estimates for U.S. stocks
0
200
400
600
800
1000
1200
1400
1600
<.10 .10 - .20 .20 - .30 .30 - .40 .40 -.50 .50 - .75 > .75
Standard Error in Beta Estimate
Num
ber o
f Firm
s
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BreakingdownDisney’sRisk
¨ RSquared=73%¨ Thisimpliesthat
¤ 73%oftheriskatDisneycomesfrommarketsources¤ 27%,therefore,comesfromfirm-specificsources
¨ Thefirm-specificriskisdiversifiableandwillnotberewarded.
¨ TheR-squaredforcompanies,globally,hasincreasedsignificantlysince2008.Whymightthisbehappening?
¨ WhataretheimplicaUonsforinvestors?
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TheRelevanceofRSquared
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¨ YouareadiversifiedinvestortryingtodecidewhetheryoushouldinvestinDisneyorAmgen.Theybothhavebetasof1.25,butDisneyhasanRSquaredof73%whileAmgen’sRsquaredisonly25%.Whichonewouldyouinvestin?¤ Amgen,becauseithasthelowerRsquared¤ Disney,becauseithasthehigherRsquared¤ Youwouldbeindifferent
¨ Wouldyouranswerbedifferentifyouwereanundiversifiedinvestor?
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BetaEsUmaUon:UsingaService(Bloomberg)
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EsUmaUngExpectedReturnsforDisneyinNovember2013
¨ InputstotheexpectedreturncalculaUon¤ Disney’sBeta=1.25¤ RiskfreeRate=2.75%(U.S.ten-yearT.BondrateinNovember2013)
¤ RiskPremium=5.76%(BasedonDisney’soperaUngexposure)
ExpectedReturn=RiskfreeRate+Beta(RiskPremium) =2.75%+1.25(5.76%)=9.95%
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UsetoaPotenUalInvestorinDisney
¨ AsapotenUalinvestorinDisney,whatdoesthisexpectedreturnof9.95%tellyou?¤ ThisisthereturnthatIcanexpecttomakeinthelongtermonDisney,
ifthestockiscorrectlypricedandtheCAPMistherightmodelforrisk,¤ ThisisthereturnthatIneedtomakeonDisneyinthelongtermto
breakevenonmyinvestmentinthestock¤ Both
¨ AssumenowthatyouareanacUveinvestorandthatyourresearchsuggeststhataninvestmentinDisneywillyield12.5%ayearforthenext5years.Basedupontheexpectedreturnof9.95%,youwould¤ Buythestock¤ Sellthestock
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Howmanagersusethisexpectedreturn
¨ ManagersatDisney¤ needtomakeatleast9.95%asareturnfortheirequityinvestorstobreakeven.
¤ thisisthehurdlerateforprojects,whentheinvestmentisanalyzedfromanequitystandpoint
¨ Inotherwords,Disney’scostofequityis9.95%.¨ Whatisthecostofnotdeliveringthiscostofequity?
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ApplicaUonTest:AnalyzingtheRiskRegression
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¨ UsingyourBloombergriskandreturnprintout,answerthefollowingquesUons:¤ Howwellorbadlydidyourstockdo,relaUvetothemarket,duringthe
periodoftheregression?¤ Intercept-(RiskfreeRate/n)(1-Beta)=Jensen’sAlpha
n wherenisthenumberofreturnperiodsinayear(12ifmonthly;52ifweekly)
¤ WhatproporUonoftheriskinyourstockisaaributabletothemarket?WhatproporUonisfirm-specific?
¤ WhatisthehistoricalesUmateofbetaforyourstock?WhatistherangeonthisesUmatewith67%probability?With95%probability?
¤ Baseduponthisbeta,whatisyouresUmateoftherequiredreturnonthisstock?
¤ RisklessRate+Beta*RiskPremium
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AQuickTest
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¨ Youareadvisingaveryriskysodwarefirmontherightcostofequitytouseinprojectanalysis.YouesUmateabetaof3.0forthefirmandcomeupwithacostofequityof20%.TheCFOofthefirmisconcernedaboutthehighcostofequityandwantstoknowwhetherthereisanythinghecandotolowerhisbeta.
¨ Howdoyoubringyourbetadown?
¨ ShouldyoufocusyouraaenUononbringingyourbetadown?¤ Yes¤ No
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RegressionDiagnosUcsforTataMotors
Beta = 1.8367% range1.67-1.99
Jensen’s α= 2.28% - 4%/12 (1-1.83) = 2.56% Annualized = (1+.0256)12-1= 35.42%Average monthly riskfree rate (2008-13) = 4%
69% market risk31% firm specific
Expected Return (in Rupees)= Riskfree Rate+ Beta*Risk premium= 6.57%+ 1.83 (7.19%) = 19.73%
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Abeaerbeta?Vale
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DeutscheBankandBaidu:IndexEffectsonRiskParameters
Aswath Damodaran
¨ ForDeutscheBank,awidelyheldEuropeanstock,wetriedboththeDAX(Germanindex)andtheFTSEEuropeanindex.
¨ ForBaidu,aNASDAQlistedstock,weranregressionsagainstboththeS&P500andtheNASDAQ.