A paper titled “Best Practice for Cost-of-Capital Estimates” (Levi and Welch, 2017) focuses on implementation recommendations for CAPM-based cost of capital estimates. The authors’ focus isn’t on finding the “right” cost of capital (which many take to be the expected return for the asset), rather they focus on methodological choices that produce the most stable values over time: namely, creating CoC estimates that best predict next period’s CoC.[Read more…]
Optimizing financing policy includes deciding how much liquidity a company should carry. In this post we find the value of an extra dollar of cash on the balance sheet.
We’re all guilty of these, at different times and in different ways. The cause is usually laziness rather than malice; either way, eternal vigilance is the best antidote.
Though we’re not fans of the CAPM definition of risk, the framework is widely known and serves as a useful reference point for discussing some very common questions. In this post we’ll look at the cost of capital for a convertible bond from a number of perspectives, including intuitive/qualitative (which provides quick directional answers) and a more precise numerical calculation.
Do you remember that feeling you got when you heard there wasn’t a Santa Claus? How about when you learned that CAPM is broken?
In a recent post, Felix Salmon suggests that Dell has done a disservice to its equity investors:
A buy-and-hold shareholder in Dell is looking particularly idiotic right now. If you bought 15 years ago at $10.84, you should expect to have at least $15.40 in value at this point: after all: that’s how much the company has made since then. Instead, you have less than you started with. And all the extra money went to fickle shareholders who sold their stock back to the company.
Would Dell’s shareholders have been better off with a dividend? Let’s investigate.. [Read more…]
If one equity is valued at 15x P/E, and another at 10x P/E, is the latter a bargain? To answer this question we should adjust for growth.
Adjusting a valuation multiple (such as P/E or EV/EBITDA) is frequently done by dividing by growth — such as with the common P/E/G multiple.
We can do better… [Read more…]
This post is a quick survey of recent literature regarding share repurchases. We look at who repurchases shares, why they do it, and whether repurchase activity affects the price or liquidity of equities.
If you invest in a private equity fund, the general partner is tasked with investing your funds. If she can’t find anything to buy, she returns the unused capital, shrinking the fund. This is the economic equivalent of a share buyback. Distributions of this sort don’t buy anything.
But the word buy in share buyback can be confusing. [Read more…]
In an earlier post we showed that, for a tax-paying firm, WACC is always a declining function of leverage. If firm value is an inverse function of WACC, this suggests funding operations with 100% debt.
In fact we observe that firm value is concave in leverage and appears to peak when there is some equity in the capital structure. We’re forced to conclude that firm value isn’t solely a function of WACC, but instead varies in a more complicated fashion with leverage. In this post we’ll review one theory that explains this, and which can guide us in divining an “optimal” capital structure. [Read more…]
Peer analysis can provide a cross check for the recommendations we derive from more normative analysis. The best peer analyses begin with a narrowly defined population of comparable firms. If the proper care isn’t given to this selection process, the results can prove misleading, as we’ll see in the following example.
There’s a surprising amount of misleading writing about capital distribution, and in particular the issue of dividend vs. share repurchase. In this post we’ll examine some common canards. [Read more…]
Once the dominant form of capital return, regular dividends have been in secular decline since the early 1980s. In this post we consider why. [Read more…]
Though quantitative analysis is interesting in its own right, we expect its practice to become more widespread if we can make money doing it. In this post we identify some choices to be made when designing a process for quantitative analysis.
Picking up Nickels
Sustainable strategies for driving revenue include picking up nickels and bagging elephants. The former tack assumes high volumes and admits the following characteristics: [Read more…]
There are lies, damn lies, statistics, and regression analyses. In this post we’ll examine some of the abuses of the last style.
Our search for understanding corporate finance leads us to drink from many questionable springs. Statistical analysis can help or hinder during the journey. A good rule of thumb is All regression analyses are wrong, but some are useful.
Our example analysis seeks to discover whether paying a dividend increases firm value. [Read more…]