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Aswath Damodaran Profile picture
@AswathDamodaran
Apr 23, 2021 • 6 tweets • 4 min read • Read on X
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The equity risk premium (ERP) is the price of risk in equity markets, the receptacle for all our fears. Each year, since 2008, I have updated a paper that includes everything I know about ERP. (Warning: It is 130 pages long...) Here is the 2021 version: bit.ly/2QQd3bB Image
As the ERP rises and falls, it drives what investors are willing to pay for stocks, and what companies demand as hurdle rates. Views on whether it is too high or too low determine whether stocks are collectively under or over valued. bit.ly/2QQd3bB Image
In practice, most analysts and companies estimate equity risk premiums by looking at the past (historical data), but that is not only backward looking, but it yields static and noisy estimates of the ERP, even for a market like the US, with a long history. bit.ly/2QQd3bB Image
An implied ERP, computed from current stock prices and expected future cash flows, is a more forward-looking and dynamic estimate. At the start of 2021, this ERP was 4.72% after a tumultuous ride during 2020. bit.ly/2QQd3bB Image
The price of risk (ERP) in equity markets moves mostly in sync with the price of risk in bond markets (default spreads) and when it does not (late 1990s, 2002-08), chaos ensues. Real estate is behaving more like stocks now than a divergent asset class. bit.ly/2QQd3bB Image
Comparing the power of different measures of ERP to predict stock market returns over next decade, the current implied ERP does best (albeit with noise) and that historical ERPs do worst. (Look at correlations with actual 10-yr ERPs) bit.ly/2QQd3bB Image

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More from @AswathDamodaran

Aswath Damodaran Profile picture
Jun 18
Most investment lessons are directed at long-only investors in publicly traded stocks & bonds, with cash as a buffer. It ignores vast swathes of the investing universe, including private businesses, short strategies & non-traded assets. bit.ly/4l6DOSpImage
These ignored investments are what comprise the alternative investing universe, and in the last two decades, they have been sold relentlessly to portfolio managers, on the promise that they will yield better risk/return trade offs. bit.ly/4l6DOSpImage
The first pitch for alternative investing is based on "low" correlations with traded stocks and bonds, where adding them on to a primarily stock/bond portfolio will generate diversification benefits. bit.ly/4l6DOSpImage
Read 11 tweets
Aswath Damodaran Profile picture
Feb 24
In my eighth data update, I look at the use of debt at businesses in 2024 to fund operations, with fictional, real and frictional reasons all causing differences in debt usage across sectors and regions. bit.ly/3D5jnnR
The debt versus equity choice begins with an understanding of the criteria that separate them - contractual vs residual cash flows, tax benefits and control of management. bit.ly/3D5jnnRImage
The illusory reasons for borrowing money include increasing ROE and debt being cheaper than equity, and for not borrowing are lower net income, lower bond ratings and debt's higher explicit costs. bit.ly/3D5jnnRImage
Read 14 tweets
Aswath Damodaran Profile picture
Feb 8
In my sixth data update for 2025, I move from macro topics (interest rates, risk premiums) to micro and look at why hurdle rates matter, what goes into them and how to estimate them, using my estimates of costs of capital across global firms to illustrate. bit.ly/4hOFmy3
If you own or run a business, you need hurdle rates to decide whether and how much to invest, how best to fund yourself and how much cash you can take out of the business. That is corporate finance in a nutshell, and the cost of capital is everywhere, bit.ly/4hOFmy3Image
In investing and valuation, the cost of capital reenters the stage, as the risk adjusted discount rate you use in valuing a business, based on its cash flows, or in the background, when you price companies. bit.ly/4hOFmy3Image
Read 14 tweets
Aswath Damodaran Profile picture
Jan 31
In my valuation writing/teaching, I argue that a good valuation is a bridge between story and numbers, and how stories can change overnight. DeepSeek's entry into the AI business has changed the AI story, but is it a break, a change or a shift? aswathdamodaran.blogspot.com/2025/01/deepse…
The AI story, pre-DeepSeek, was built around a lucrative end market for AI products/services, and high entry costs (investments in computing power & data), leading to a profitable, big business, with a (few) winners collection huge spoils. aswathdamodaran.blogspot.com/2025/01/deepse…Image
The pre-DeepSeek AI story played out in markets, pushing up the pricing of players in the space, from firms building the architecture (chips, power) to firms aiming for the product/service market (from Palantir to big tech). aswathdamodaran.blogspot.com/2025/01/deepse…Image
Read 13 tweets
Aswath Damodaran Profile picture
Jan 10
It the end of the first full week in 2025, and my annual data update for 2025 is ready. You can find the details on the companies used, the variables that I measure and the estimation processes here. bit.ly/408MIW5
The sample includes all publicly traded companies, listed globally, with a market price greater than zero. There are 47810 companies in the sample, and the US dominates, at least in terms of market capitalization. bit.ly/408MIW5Image
Over the last three years, the US has increased its share of global market cap from 42% to 49%, as China and Europe have seen their shares shrink. bit.ly/408MIW5Image
Read 10 tweets
Aswath Damodaran Profile picture
Dec 11, 2024
At the start of every year, I invite people to sit in the classes that I teach at NYU Stern, at least virtually. As the spring 2025 semester approaches, I am having an open house for all of my classes. Drop by, if you have the time. bit.ly/3ZA956q
I teach because I like the stage, making a difference in how people think and their career choices and not having a boss. Teaching may not be held in much esteem any more, but I love teaching, and there is nothing else that I would rather do. bit.ly/3ZA956q
There is no one template for teaching, but mine is built around teaching classes that have a story line, and using real companies in real time. I hope that I stay true to my motto that I would rather be transparently wrong than opaquely right. bit.ly/3ZA956q
Read 14 tweets

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