Measuring the Relative Performance of Small Stock vs. Large Stock and the Cost of Equity Roger Ibbotson and James Harrington discuss two different ways of measuring the relative performance of small stocks versus large stocks in this article: (i) the “small stock premium” and (ii) the “beta-adjusted size premium”. Ibbotson and Harrington demonstrate why using a non-beta-adjusted size premium within the context of the capital asset pricing model (CAPM) to estimate cost of equity capital will likely “double count” beta risk, and therefore overstate risk and understate value. The authors also demonstrate that a non-beta-adjusted size premium used in conjunction…
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Fair Value Not Based on the Merger Price (Part II of II) This is the second of a two-part article (read part one here) that focuses on the SWS Group, Inc. case and the interplay between merger price and fair value. In earlier cases, the Delaware Court of Chancery rejected a merger price indication in favor of its own discounted cash flow analysis. Yet, in the SWS Group, Inc. appraisal decision, instead of a decision supporting a higher fair value, the court ultimately found that the merger price was too high. This ruling highlights the risk of an arbitrage appraisal…
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A Critique of the Ibbotson Methodology In this paper, the author argues that the Size Premium in Excess of CAPM (and other similar size premium measures) should not be used by valuation practitioners because: a) it is inconsistent with the empirical evidence; b) it is constructed using a method that is inconsistent with how practitioners estimate their CAPM cost of equity; and c) it does not properly calculate the “premium” for use in a Discounted Cash Flow (DCF) analysis. Through an illustration, the author also demonstrates the challenges one faces when correcting for the latter two issues.
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Fair value litigation and more The Delaware Chancery Court is considered one of the pre-eminent U.S. courts when it comes to business valuation and governance issues. This article reviews some recent court decisions pertinent to valuation practitioners and which will be discussed in more detail in NACVA’s Federal and State Case Law Update this fall.
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Summary and Solutions Morningstar announced in September 2013 it will discontinue publishing the SBBI Valuation Yearbook, but that it will continue to publish the Ibbotson SBBI Classic Yearbook. James Harrington, who was previously director of business valuation research in Morningstar’s Financial Communications Business, provides a summary of which data is being discontinued and continued, along with a discussion of alternative data sources in light of the recent announcement.
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Valuators Must be More Than “Lucky Punks” How can appraisers best figure the cost of equity capital? Rand M. Curtiss argues that using standard tools including Ibbottson, Duff & Phelps, CAPM, or the Butler-Pinkerton model aren’t enough. What to use instead? Curtiss suggests starting with a look at the rate of return on mezzanine money and the rate of return on later-stage VC investments. Find out why.