ChoosingtheParameters:Disney
¨ 
¨ 
¨ 
¨ 
Periodused:5years
ReturnInterval=Monthly
MarketIndex:S&P500Index.
Forinstance,tocalculatereturnsonDisneyinDecember2009,
¤ 
¤ 
¤ 
¤ 
¨ 
PriceforDisneyatendofNovember2009=$30.22
PriceforDisneyatendofDecember2009=$32.25
Dividendsduringmonth=$0.35(Itwasanex-dividendmonth)
Return=($32.25-$30.22+$0.35)/$30.22=7.88%
ToesUmatereturnsontheindexinthesamemonth
¤ 
¤ 
¤ 
¤ 
IndexlevelatendofNovember2009=1095.63
IndexlevelatendofDecember2009=1115.10
DividendsonindexinDecember2009=1.683
Return=(1115.1–1095.63+1.683)/1095.63=1.78%
Aswath Damodaran
124
Disney’sHistoricalBeta
!
ReturnonDisney=.0071+1.2517ReturnonMarketR²=0.73386
(0.10)
AnalyzingDisney’sPerformance
¨ 
Intercept=0.712%
¤ 
¤ 
¨ 
TheComparisonisthenbetween
¤ 
¤ 
¤ 
¨ 
Thisisaninterceptbasedonmonthlyreturns.Thus,ithastobe
comparedtoamonthlyriskfreerate.
Between2008and2013
n  AverageAnnualizedT.Billrate=0.50%
n  MonthlyRiskfreeRate=0.5%/12=0.042%
n  RiskfreeRate(1-Beta)=0.042%(1-1.252)=-.0105%
Intercept versus RiskfreeRate(1-Beta)
0.712% versus 0.0105%
Jensen’sAlpha=0.712%-(-0.0105)%=0.723%
Disneydid0.723%beaerthanexpected,permonth,between
October2008andSeptember2013
¤ 
Annualized,Disney’sannualexcessreturn=(1.00723)12-1=9.02%
Aswath Damodaran
126
MoreonJensen’sAlpha
127
¨ 
Ifyoudidthisanalysisoneverystocklistedonanexchange,whatwouldthe
averageJensen’salphabeacrossallstocks?
a. 
b. 
c. 
¨ 
DisneyhasaposiUveJensen’salphaof9.02%ayearbetween2008and2013.This
canbeviewedasasignthatmanagementinthefirmdidagoodjob,managing
thefirmduringtheperiod.
a. 
b. 
¨ 
Dependuponwhetherthemarketwentupordownduringtheperiod
Shouldbezero
Shouldbegreaterthanzero,becausestockstendtogoupmoreodenthandown.
True
False
DisneyhashadaposiUveJensen’salphabetween2008and2013.Ifyouwerean
investorinearly2014,lookingatthestock,youwouldviewthisasasignthatthe
stockwillbea:
a. 
b. 
c. 
Goodinvestmentforthefuture
Badinvestmentforthefuture
NoinformaUonaboutthefuture
AswathDamodaran
127
EsUmaUngDisney’sBeta
¨ 
¨ 
¨ 
SlopeoftheRegressionof1.25isthebeta
RegressionparametersarealwaysesUmatedwitherror.
Theerroriscapturedinthestandarderrorofthebeta
esUmate,whichinthecaseofDisneyis0.10.
AssumethatIaskedyouwhatDisney’struebetais,
aderthisregression.
¤ 
WhatisyourbestpointesUmate?
¤ 
Whatrangewouldyougiveme,with67%confidence?
¤ 
Whatrangewouldyougiveme,with95%confidence?
Aswath Damodaran
128
TheDirtySecretof“StandardError” Distribution of Standard Errors: Beta Estimates for U.S. stocks
1600
1400
Number of Firms
1200
1000
800
600
400
200
0
<.10
.10 - .20 .20 - .30 .30 - .40
.40 -.50
.50 - .75
> .75
Standard Error in Beta Estimate
Aswath Damodaran
129
BreakingdownDisney’sRisk
¨ 
¨ 
RSquared=73%
Thisimpliesthat
73%oftheriskatDisneycomesfrommarketsources
¤  27%,therefore,comesfromfirm-specificsources
¤ 
¨ 
¨ 
Thefirm-specificriskisdiversifiableandwillnotbe
rewarded.
TheR-squaredforcompanies,globally,hasincreased
significantlysince2008.Whymightthisbehappening?
¨ 
WhataretheimplicaUonsforinvestors?
Aswath Damodaran
130
TheRelevanceofRSquared
131
¨ 
Youareadiversifiedinvestortryingtodecide
whetheryoushouldinvestinDisneyorAmgen.They
bothhavebetasof1.25,butDisneyhasanR
Squaredof73%whileAmgen’sRsquaredisonly
25%.Whichonewouldyouinvestin?
¤  Amgen,becauseithasthelowerRsquared
¤  Disney,becauseithasthehigherRsquared
¤  Youwouldbeindifferent
¨ 
Wouldyouranswerbedifferentifyouwerean
undiversifiedinvestor?
AswathDamodaran
131
BetaEsUmaUon:UsingaService
(Bloomberg)
Aswath Damodaran
132
EsUmaUngExpectedReturnsforDisneyin
November2013
¨ 
InputstotheexpectedreturncalculaUon
¤  Disney’sBeta=1.25
¤  RiskfreeRate=2.75%(U.S.ten-yearT.Bondratein
November2013)
¤  RiskPremium=5.76%(BasedonDisney’soperaUng
exposure)
ExpectedReturn=RiskfreeRate+Beta(RiskPremium)
=2.75%+1.25(5.76%)=9.95%
Aswath Damodaran
133
UsetoaPotenUalInvestorinDisney
¨ 
AsapotenUalinvestorinDisney,whatdoesthisexpected
returnof9.95%tellyou?
¤ 
¤ 
¤ 
¨ 
ThisisthereturnthatIcanexpecttomakeinthelongtermonDisney,
ifthestockiscorrectlypricedandtheCAPMistherightmodelforrisk,
ThisisthereturnthatIneedtomakeonDisneyinthelongtermto
breakevenonmyinvestmentinthestock
Both
AssumenowthatyouareanacUveinvestorandthatyour
researchsuggeststhataninvestmentinDisneywillyield
12.5%ayearforthenext5years.Basedupontheexpected
returnof9.95%,youwould
¤ 
¤ 
Buythestock
Sellthestock
Aswath Damodaran
134
Howmanagersusethisexpectedreturn
¨ 
ManagersatDisney
¤  needtomakeatleast9.95%asareturnfortheirequity
investorstobreakeven.
¤  thisisthehurdlerateforprojects,whentheinvestmentis
analyzedfromanequitystandpoint
Inotherwords,Disney’scostofequityis9.95%.
¨  Whatisthecostofnotdeliveringthiscostofequity?
¨ 
Aswath Damodaran
135
ApplicaUonTest:AnalyzingtheRiskRegression
136
¨ 
UsingyourBloombergriskandreturnprintout,answerthe
followingquesUons:
¤ 
¤ 
¤ 
¤ 
¤ 
¤ 
Howwellorbadlydidyourstockdo,relaUvetothemarket,duringthe
periodoftheregression?
Intercept-(RiskfreeRate/n)(1-Beta)=Jensen’sAlpha
n  wherenisthenumberofreturnperiodsinayear(12ifmonthly;52
ifweekly)
WhatproporUonoftheriskinyourstockisaaributabletothemarket?
WhatproporUonisfirm-specific?
WhatisthehistoricalesUmateofbetaforyourstock?Whatisthe
rangeonthisesUmatewith67%probability?With95%probability?
Baseduponthisbeta,whatisyouresUmateoftherequiredreturnon
thisstock?
RisklessRate+Beta*RiskPremium
AswathDamodaran
136
AQuickTest
137
¨ 
Youareadvisingaveryriskysodwarefirmontherightcostof
equitytouseinprojectanalysis.YouesUmateabetaof3.0
forthefirmandcomeupwithacostofequityof20%.The
CFOofthefirmisconcernedaboutthehighcostofequity
andwantstoknowwhetherthereisanythinghecandoto
lowerhisbeta.
Howdoyoubringyourbetadown?
¨ 
ShouldyoufocusyouraaenUononbringingyourbetadown?
¨ 
¤ 
¤ 
Yes
No
AswathDamodaran
137
RegressionDiagnosUcsforTataMotors
Beta = 1.83
67% range
1.67-1.99
69% market risk
31% firm specific
Jensen’s α
= 2.28% - 4%/12 (1-1.83) = 2.56%
Annualized = (1+.0256)12-1= 35.42%
Average monthly riskfree rate (2008-13) = 4%
Aswath Damodaran
Expected Return (in Rupees)
= Riskfree Rate+ Beta*Risk premium
= 6.57%+ 1.83 (7.19%) = 19.73%
138
Abeaerbeta?Vale
Aswath Damodaran
139
DeutscheBankandBaidu:IndexEffectson
RiskParameters
¨ 
¨ 
ForDeutscheBank,awidelyheldEuropeanstock,
wetriedboththeDAX(Germanindex)andtheFTSE
Europeanindex.
ForBaidu,aNASDAQlistedstock,weranregressions
againstboththeS&P500andtheNASDAQ.
Aswath Damodaran
140