Historical equity risk premium? “I don’t like a backward-looking and stagnant premium.” A “normalized” risk-free rate? “Don’t use it.” The size premium? “Fiction!” Company-specific risk premium? “[expletive deleted]!!” Never one to mince words, Aswath Damodaran (New York University Stern School of Business) aired his strong views in response to questions from the audience during a recent BVR webinar. His opinions are always thought-provoking, and he gave some solid advice on valuing companies amid inflation.

A full recap of the webinar appears in the August issue of Business Valuation Update.

Inflation and valuation: The webinar title was “In Search of a Steady State: Inflation, Interest Rates, and Value; The (Inflation) Genie Escapes the Bottle!” He’s done a number of lectures on this, but we asked him to focus on the practical aspects of how valuation experts should assess the impacts of inflation when valuing a private company. Damodaran pointed out that there are disparate effects of inflation, and the value of some companies will be unaffected, others will be negatively affected (to varying degrees), and a few may actually benefit from inflation.

He advised experts to go “back to fundamentals” and examine six basic variables when determining how sensitive your subject company is to inflation. One variable is “pricing power,” which is the ability of companies to pass inflation on to customers. Of course, the more power a company has that enables it to pass price increases on to customers, the more protected it would be from inflation. The other variables are cost structure (margins), investment efficiency, cost of equity, cost of debt, and what he terms “failure risk,” which is a separate variable not reflected in cash flows nor the discount rate.