Musings on Markets Thu, 27 Feb 2020 21:38:00 GMT language
- Betas: I start with betas, estimated with conventional regressions of returns on the stock against a market index, for each of the companies in my sample. To get a measure of how these betas vary across companies, I have a distribution of betas, broken down globally and for regions of the world:
It is worth noting that, at least for public companies, half of all companies have betas between 0.85 and 1.45, globally. If you are wondering why the betas are not higher for companies in riskier parts of the word, it is worth emphasizing that betas are scaled around one, no matter of the world you are in, and are not designed to convey country risk. (The equity risk premiums that I wrote about in my last post carry that weight.)
- Relative Standard Deviation: For those who do not buy into the notion that the marginal investors are diversified and that the only risk that matters is market risk, I report on the standard deviation in stock prices (using the last two years of data):
Note that you can convert these numbers into relative measures, resembling betas, by dividing by the average standard deviation of all stocks. Thus, if you have a US stock with an annualized standard deviation of 35.00% in stock returns, you would divide that number by the average for US equities of 42.36% to arrive a relative standard deviation of 0.826 (=35.00%/42.36%).
- High-Low Risk: For those who prefer a non-parametric and more intuitive measure of risk, I compute a risk measure by looking at the difference between high and low prices in the most recent year, and dividing by the sum of the two numbers. Thus, for a stock that has a high price of 20 and a low price of 12, during the course of a year, this measure would yield 0.25 ((20-12)/ (20+12)). Note that the bigger the range in prices, the more risky a stock looks on this measure, and this too is broken down globally and by region:
As with the other risk measures, this too can be converted into a relative risk measure, by dividing by the average.
- Earnings Variability: Finally, for those who trust accountants more than markets (even though I am not one of them), I have computed a risk measure that is built around earnings variability, computed by looking at the standard deviation in net income over the last 10 years for each firm, and converted into a standardized measure, by dividing by the average net income over the ten years (a coefficient of variation in net income), The global and regional breakdown is below:
The earnings variability number has a bigger selection bias than the other measures, because it requires a longer history (10 years of data) and positive earnings, cutting the sample size down significantly. Here again, dividing a company's coefficient of variation in net income by the average value across all companies will give you a relative risk measure.
- The risk free rate is a function of the currency you choose to compute your hurdle rates in, and will be higher for high-inflation currencies than low-inflations ones. Since I will be comparing and aggregating costs of equity across more than 40,000 firms spread across the world, I will compute their costs of equity in US dollars, using the US T.Bond rate as of January 1, 2020, as the risk free rate. You can convert these into any other currency, using the differential inflation approach that I described in my earlier post from a couple of weeks ago.
- The equity risk premium for a company is a function of where it does business, and in my last data update post, I described my approach to estimating equity risk premiums for individual countries, and the process of weighting these (using either revenues or production) to get equity risk premiums for companies.
- For the relative risk measure, I will use betas but as I argued in the last section, I am agnostic about what you prefer to use instead. Thus, if you prefer earnings variabliity as a measure, you can use relative earnings variability as your risk measure.
- Industry Average Risk Measures at start of 2020
- Betas, by industry (Global, US, Emerging Markets, Europe, Japan, Australia/Canada, India, China)
- Costs of Debt, Equity and Capital, by industry (Global, US, Emerging Markets, Europe, Japan, Australia/Canada, India, China)
- Marginal tax rates, by country, for 2020