- The blunt Cape metric has its uses
- You should quantify the potential pay-off for taking risk
Volatile financial markets have added to a summer of unrest around the world. It’s a reminder of the partially self-fulfilling nature of investment risk: when fear trumps greed, prices fall because buyers demand more of a premium.
It follows that cheap investments aren’t automatically good value, just as expensive ones aren’t necessarily in bubble territory. True bargains must be attractively priced relative to the size of potential reward, and to the degree of confidence that this reward will be realised.
An investor’s required rate of return can be extrapolated from forecast cash flows and today’s price. In the case of shares, this return is also known as the cost of equity, and it’s typically higher for smaller companies and those with lower quality or less predictable earnings.
…
