of a Publicly-traded Stock
November 2024
A discount rate in a business valuation reflects the valuator’s judgment for the return that a prudent investor would require to adequately compensate him for alternative investment opportunities, and for the particular business and financial risks associated with an investment in the subject company. Furthermore, as stated in “Kroll’s Valuation Handbook - U.S. Guide to Cost of Capital,” the discount rate is always an expectational or forward-looking concept. While past performance of an investment and other historical information can be a good guide, and is often used to estimate the required rate of return, the expectations of future events are the factors that actually determine the discount rate.
When choosing guideline public companies in the market approach to valuing a business, it is often useful to calculate the discount rate of the prospective guideline companies to see if they are reasonably comparable. An unusually high or low discount rate would prompt further analysis to see why the discount rate deviated from the norm.
The discount rate for a publicly-traded stock can be estimated by inverting the company’s P/E (price to earnings) ratio and then adding projected long-term growth in earnings. For example, Emerson Electric’s (ticker “EMR”) P/E ratio (12 months trailing) as of November 15, 2024 was 47.97 and estimated 3- to 5-year annual growth in earnings per year was 10.54%. The discount rate is calculated as 12.62% [(1 ÷ 47.97) + 0.1054].
Relevant Court Cases
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Magarik v. Kraus USA, Inc.,
Supreme Court of Appeals of the State of New York,
2024 NY Slip Op 04964,
decided October 9, 2024
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Fasi v. Fasi,
Intermediate Court of Appeals of the State of Hawaii,
FC-D No. 17-1-6358,
filed October 31, 2024
Recent Business Valuation Articles
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“Investment Valuation of High Growth
Firms: Practical Case Analysis,”
by Yulia A. Lukina,
dated November 4, 2024
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“A Unified Framework for Value and Momentum,”
by Jacob Boudoukh, Tobias Moskowitz, Matthew Richardson and Lei Xie,
posted November 2024
Recent Engagements
- Valuation of the voting and
non-voting common stock
of a real estate investment
company on a minority interest
basis for gift tax reporting
purposes.
- Valuation of the non-voting
common stock of a niche chemical
products firm on a minority
interest basis for stock option
issuance and purchase/sale purposes.
- Valuation of limited partnership
interests of an investment holding
partnership on a minority interest
basis for gift tax reporting
purposes.
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