We’ve been saying for years investors DO NOT understand risk. The numerator (cash flow) has not shifted much over the past quarter-it’s the denominator, cost of capital, as only can be measured by our comprehensive credit model, factoring everything from tax rate and revenue stability, free and operating cash flows, yield spreads, and 50 other metrics, all carefully defined.
The problem is, in a nutshell, investors are setting risk thru the Capital Asset Pricing Model, which is terribly flawed. They look towards EDITDA, which is terribly flawed.
COMING THIS FALL: Cash Flow, Cost of Capital, and Security Valuation, McGraw-Hill
Central Tenet: The risk premium should not be set by stock volatility, as implied by the capital asset pricing model, but by the cash flows and credit worthiness of the entity.