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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
Apr 9
I like writing and I am verbose, an occupational hazard when time is your ally and you have a captive audience. Most of my books are long and stretch on forever, but my Little Book of Valuation (Wiley) is the exception.
That 2011 edition is aging. I just finished an update, and the new edition is now available at booksellers (online or physical) near you. Much of the original material is intact, but the valuations have been updated with a new chapter on story telling. bit.ly/49y0kgd
I have a YouTube series that supports the book, with a session for each chapter. Chapter one lays out the big picture and lists the three biggest impediments to a good valuation – bias, uncertainty and complexity.
Read 15 tweets
Aswath Damodaran Profile picture
Mar 30
As the market climbs, the implied ERP for the S&P 500 drops to 4.23%, its lowest value since 2008. As a forward-looking price of risk, the ERP drives everything in markets. I have a review that I do on ERP, and my fifteenth annual update is now available: bit.ly/49fSBU0
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The paper is verbose (155 pages) and not riveting reading, but it does include everything I know about equity risk premiums and their estimation. My first update was written in 2009, during the financial crisis, and I have updated it annually since. bit.ly/49fSBU0
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The equity risk premium is the ultimate market barometer, reflecting the battle between greed and fear that animates market. More generally, its level is determined by macro forces, information disclosure and behavioral forces. bit.ly/49fSBU0
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Read 14 tweets
Aswath Damodaran Profile picture
Feb 17
A data hack at 23andMe, a volcanic eruption in Iceland and a global pandemic are all catastrophes, the first to just one firm, the second to a country and the third to the world. I look at catastrophic risks, and how they play out in valuation and pricing. bit.ly/3SJi9Th
As humans, we are not good at dealing with catastrophic risks, swinging between denial when it is dormant and panic when it is imminent. Living in a home on an earthquake fault, two blocks from the ocean, I am no exception. bit.ly/3SJi9Th
Catastrophic risks have many sources (acts of God, manmade, regulatory or legal), can affect just a few or many, and can be low-chance or high-likelihood events. Those differences can affect how we deal with them. bit.ly/3SJi9Th
Read 14 tweets
Aswath Damodaran Profile picture
Feb 9
Seven stocks (Amazon, Apple, Alphabet, Meta, Microsoft, Nvidia, Tesla) added $5.1 trillion to their market cap in 2023, accounting for about 55% of the $9.2 trillion added during the year by all 6658 US firms. bit.ly/4bsNEcB
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Going back a decade, these seven stocks have climbed from 8% of the value of all US firms to more than 24% of the value, with 2022 the only serious drawdown year. At a $12 trillion market cap, the Mag Seven are now worth more than all listed Chinese stocks. bit.ly/4bsNEcBImage
A US stock portfolio created in Dec 2012 without the Mag Seven stocks in it, would have had a shortfall of about 18% in cumulated value by the end of 2023, relative to a portfolio with these stocks. Small stock and value investors suffered! bit.ly/4bsNEcB
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Read 11 tweets
Aswath Damodaran Profile picture
Feb 1
In my fifth data update for 2024, I look at the profitability of companies, scaled to both sales and invested capital, broken down by sector, region and corporate age. bit.ly/3Uo4mns
There are multiple stakeholders in businesses, but we give shareholders primacy in businesses, not because we are playing favorites, but because they are only stakeholders whose claims are residual, not contractual. bit.ly/3Uo4mns
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The notion of stakeholder wealth maximization sounds good, but in practice, it and allows managers to escape accountability and contributes to "confused corporatism". bit.ly/3w0C34s
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Read 12 tweets
Aswath Damodaran Profile picture
Jan 28
In my fourth data update for 2024, I look at risk, a central player in any discussion of business & investing, and examine how to measure it, why it varies across companies, countries & sectors and how it plays out in hurdle rates. bit.ly/48QlJ4O
Finance has advanced the study of risk, but it has skewed too much to price-based measures & putting a number on risk more than recognizing how it affects investor psyche. Ultimately, risk is neither good nor bad. It is a pairing of danger & opportunity. bit.ly/48QlJ4O
Modern risk and return models are elegant, but they are built on two key assumptions, that marginal investors are diversified and that price changes convey information about risk. Both are debatable! bit.ly/48QlJ4O
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Read 10 tweets

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