Toyota Motor Company’s recent safety concerns present an extraordinary chance to see how betas and cost of capital change, comments Pete Butler. "This has been a rather quick and precipitous fall from grace, but it is also a testament to how quickly goodwill and an impeccable reputation can evaporate," Pete points out.
Looking at the market returns of a few weeks ago shows the impact.
Toyota’s stock price.
Date Close Volume
26-Jan-10 86.78 263,000
27-Jan-10 79.77 3,481,200
28-Jan-10 77.67 4,039,700
29-Jan-10 77.00 2,530,400
1-Feb-10 79.94 2,984,200
2-Feb-10 78.18 3,520,900
3-Feb-10 73.49 18,462,000
4-Feb-10 71.78 10,952,900
What does Pete think business appraisers learn from this unfortunate state of events? Some things it proves, in his mind, are:
• If a firm like Toyota has company-specific risk, rest assured every single private company we have ever valued has company-specific risk. "Thus in the build-up method, never apply an absolute negative company-specific risk premium to your subject company. Please do not confuse that statement with the following: Some companies are more risky than others. If your subject company is less risky than a particular publicly-traded guideline, then lower its cost of equity capital using the guideline as a reference."
• The rather precipitous drop in Toyota’s stock price certainly was not telegraphed by historical financial results. "Accounting results can (and often do) hide risks. For example, if a stock analyst looked (only) to historical operating margins to help assess risk and develop a cost of capital for Toyota, then he or she would have completely missed the problems with the company. (In all fairness, it may be unlikely that a stock analyst would have uncovered the issue by other means unless he or she was unfortunate enough to be in a car accident with a sticky Toyota accelerator). However, if you are valuing a privately-held manufacturing company that may be facing quality control problems and/or related litigation, you just might want to look to Toyota as some type of timely (and very specific) benchmark."
Pete suggests that appraisers watch how Toyota’s total beta changes relative to its past over the next few months. "It is a very different company today than it was before these safety concerns came to light, and we can watch it in real-time, rather than looking backward with accounting metrics," he says.