Both Cost of Equity Capital and Free Cash Flow Multiple Fell Last Week

June 20th, 2010 by hackel Leave a reply »

The median free cash flow multiple for the S&P Industrials fell to 16.8x and the cost of equity to 8.6%, the first time this has occurred in four months.

This is a bullish sign given the free cash flow multiple is in the bottom half of the valuation funnel. Holding the equity market back thus far in 2010 has, no doubt, been the upward re-valuation of risk. A large caveat is the cost of capital (risk), is in the top half of historic ranges, indicative of a volatile equity market with considerable risk. When the two are placed into a model, total valuation is indicative of an undervalued equity market which bears slightly more reward than risk for the patient investor.

Given the cost of capital/free cash flow valuation is in the lower half of the funnel, it would appear, baring an increase in the cost of capital, the nascent rally has a good chance for continuation over the coming year. As a whole, the S&P Industrials are undervalued by 5%

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