Tuesday, March 1, 2011

How do you estimate the equity premium and what is it now?

Aswath Damodaran discusses the different ways of estimating the equity premium and provides some current estimates from these methods.

Bottom line - here are the ranges:
Surveys: 3-4%
Historic evidence: 4.3% (but very noisy)
Implied (from stock prices): About 5%

Consider this:- if the premium is about 4%, and the long term bond yield is about 4.5%, then you are looking at an 8.5% return on stocks.  8.5% is a far more modest return assumption than the 10-12% number you often hear as the "long run return on stocks".

Pretty much essential reading for all finance students.