As a commerce graduate, am very familiar with all of the asset pricing models..
Yes, the risk free rate has gone down, but I would argue very strongly that the discount rate has stayed the same, or actually risen.
Why?
Because you need to assign a greater uncertainty to the future cash flows...
The greater the variability in future cash flows, the greater the risk premia that needs to be applied.
Do you really think that anyone can accurately forecast earnings next year, give all of the uncertainty? I can't in my business.. . Who knows. We are at the mercy of the virus, and governments responses. Will we lock down hard again? Will international travel resume and when? Will more stimulus be rolled out, and what will it look like?
My EBITDA has gone to between 0 and 60% of what it was in February. It changes monthly. Its impossibly to say what my EBITDA will look like in 6 months time. This is from a 10 year old business, that does 60-70K transactions a week......That's a lot of customers, and a very broad base...
My second thought on this topic, is that I would question whether the second grand assumption in all asset pricing models, is currently valid..
The assumptions are
"Modern financial theory rests on two assumptions: (1) securities markets are very competitive and efficient (that is, relevant information about the companies is quickly and universally distributed and absorbed); (2) these markets are dominated by rational, risk-averse investors, who seek to maximize satisfaction from returns on their investments.
I think assumption 2 is possibly not valid atm, given the prevalence of retail/robinhood...
I don't think retail investors have ever heard of DCF or CAPM...
The bond markets on the other hand, are signalling something very different to US equity markets....
Food for thought!!!!
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