Using the Price to Earnings Ratio to Derive the Cost of Equity

Videos Associated with Valuation Concepts Lesson Set 1: Using Methods other than CAPM to Estimate the Cost of Capital

The set of videos for the cost of capital begins with an introduction to an approach that collects data from finance.yahoo.com and from marketwatch.com on stock prices, historic financial information, interest rates, earnings rates and growth rates. The database evaluates historic market to book ratios relative to projected return on equity to evaluate cost of capital. In addition PE ratios and published growth estimates are used along with assumed transition rates to back into the cost of capital. The CAPM is also computed along with the dividend discount model. The next set of videos explain the theory behind using the market to book ratio and the P/E ratio using simulation and sensitivity analysis. The final set of videos in the set explain details of how to build the data base.

 

 

Cost of Capital Subject File Reference Video Link
Cost of Captial Database Introduction Dow 30 Companies https://www.youtube.com/watch?v=MOpSVBstv4o
Cost of Capital Sensitivity Analysis Using the P/E Ratio Formula Price to Earnings Analysis https://www.youtube.com/watch?v=A5FoWknb0HM
P/E Cost of Capital and Scenario Reporter Scenario reporter https://www.youtube.com/watch?v=j5DOUe6Wqbk
P/E ratio and Cost of Capital with Transition and Interpolation (Number 6) Interpolate and Lookup https://www.youtube.com/watch?v=XLVqKfvmjCM
P/B Regression Simulations for the Cost of Capital (Number 5) Price to Book https://www.youtube.com/watch?v=bhYlYSSWDVw
P/B Formulas and Cost of Capital Price to Book https://www.youtube.com/watch?v=s2NdJs8Su44
Demonstration of Problems with CAPM Beer Companies Database https://www.youtube.com/watch?v=PL0zOQe-_6c
Collecting Data with Ticker Symbols Cost of Captial Database https://www.youtube.com/watch?v=MTskVI_VERk
Bulding Cost of Capital Data with Indirect Function Cost of Captial Database https://www.youtube.com/watch?v=UBl_pAvxhbs
Problems with Beta and Measuring Cost of Capital Renewable Stock Price https://www.youtube.com/watch?v=eTDjLjZo9cE
Use of Market P/E Ratio to Derive Cost of Capital Economy Wide Cost of Capital https://www.youtube.com/watch?v=GAolSYR1-pc
DCF Model Integrated Electricity Model https://www.youtube.com/watch?v=9rsxSVDbjxE
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Files Used in Advanced Valuation Concepts Lesson Set 1: Using Methods other than CAPM to Estimate the Cost of Capital

There are two general sets of files associated with the cost of capital analysis. The first set of files in the cost of capital set work through the theory of valuation and alternatives to the CAPM. The second set of files show how the models work with real market data. The set of files and videos below include both development of spreadsheets that measure the theory and explanation of how to construct comprehensive financial ratio databases that can be automatically uploaded to evaluate cost of capital. Deriving the cost of capital from the P/E ratio requires a lot of assumptions about long-term ROE versus cost of capital, long-term growth, inflation rates and transition periods. The P/E ratio files and videos use alternative scenario analyses to demonstrate the difficulty. The P/E Analysis file below evaluates the cost of capital with sensitivity and scenario analysis. It demonstrates how to correct the value driver formula P/E = (1-g/ROE)/(k-g) for inflation and changing returns.

This files below evaluates the price to book ratio analysis with regression analysis and shows how to develop the formula: PB = (ROE-g)/(k-g). It shows how you can use the market to book ratio to compute cost of capital and it demonstrates how a regression equation for the market to book ratio can be used to evaluate the cost of capital. If the CAPM is a biased and flawed model, bizarre attempts to adjust the cost of capital for country risk resulting in premiums as much as 11% for some countries. These CAPM derived premiums published by a man named Mr. Damoradan and frequently used have to imply that the real cost of all sorts of products ranging from houses to electricity can be as much as double for so-called risky countries.

If you want to earn a badge for the cost of capital course, you first pick an industry, then you put your own ticker symbols into one of the three above files. Next, clear the existing sheets and re-run the macro to compute the cost of capital. Finally, send me the file with your industry and go through the various different methods to remove companies (with the TRUE/FALSE switch). Even though you will be doing me a favour by doing the painful job of finding the ticker symbols and entering them in a file, I will still charge 40 Euros for putting your name on the website. I will also post your file on this page and give you credit. According to modern marketing theory, you will feel much better about this process when you have to pay me money than if you did not have to pay. That is why I must charge a fee.