When you drive your car, should you look through your windshield or the rearview mirror? True, looking at where you’ve been may give you some indication of where you’re headed, but most would opt for looking straight ahead. As a valuation expert, do you look backwards to historical returns to estimate expected returns? That’s the question for our latest in a series of minisurveys on the cost of capital. This one is on the equity risk premium (ERP), which the “dean of valuation,” Professor Aswath Damodaran
(Stern School of Business, New York University), calls the “number that drives everything we do.” In the latest update to his paper, “Equity Risk Premiums (ERP): Determinants, Estimation and Implications
,” he describes the three basic approaches used to estimate the ERP: (1) the historical return approach; (2) the implied approach (which he prefers), which is an internal rate of return (using future cash flows and current stock prices); and (3) the survey approach, where investors or managers are asked to provide estimates of the ERP for the future. Which do you prefer? Please take our short survey by clicking here
, and we’ll report the results in the next issue. By the way, if you’re driving using your rearview mirror and you see that you’re on a pier, you may want to consider hitting the brakes.
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