Also called CAPM, capital asset pricing model
Cost of equity
The return shareholders demand for owning this particular company. Known as CAPM, the capital asset pricing model.
How it is calculated
Cost of equity = risk-free rate + beta × equity risk premium
A fuller explanation of this one is still being written. The definition above is the short answer.
See also
- WACC — Cost of equity and cost of debt blended by how much of each the company uses. This is the rate every future dollar is discounted at, and it is the single most leveraged input in the model.
- Beta — How much the stock moves relative to the S&P 500. A beta of 1.0 moves with the market, higher is more volatile, and higher volatility raises the discount rate.
- Risk-free rate — The 10-year Treasury yield, standing in for the return available with essentially no risk. Every other rate in the model is built on top of it.
- Equity risk premium — The extra return investors demand for holding stocks instead of Treasuries. Beta scales it up or down for one particular company.
Educational content, not investment advice. Angie explains how a valuation is built so you can judge it yourself. What you do with that is your call.
