Also called ERP
Equity risk premium
The extra return investors demand for holding stocks instead of Treasuries. Beta scales it up or down for one particular company.
How it is calculated
Equity risk premium = market return − risk-free rate
A fuller explanation of this one is still being written. The definition above is the short answer.
See also
- Cost of equity — The return shareholders demand for owning this particular company. Known as CAPM, the capital asset pricing 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.
- Market return — The expected long-run return of the broad market. Subtract the risk-free rate from it and what remains is the equity risk premium.
- 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.
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.
