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The Risk Premium Factor: A New Model for Understanding the Volatile Forces that Drive Stock Prices

Book Description

A radical, definitive explanation of the link between loss aversion theory, the equity risk premium and stock price, and how to profit from it

The Risk Premium Factor presents and proves a radical new theory that explains the stock market, offering a quantitative explanation for all the booms, busts, bubbles, and multiple expansions and contractions of the market we have experienced over the past half-century.

Written by Stephen D. Hassett, a corporate development executive, author and specialist in value management, mergers and acquisitions, new venture strategy, development, and execution for high technology, SaaS, web, and mobile businesses, the book convincingly demonstrates that the equity risk premium is proportional to long-term Treasury yields, establishing a connection to loss aversion theory.

  • Explains stock prices from 1960 through the present including the 2008/09 "market meltdown"

  • Shows how the S&P 500 has consistently reverted to values predicted by the model

  • Solves the equity premium puzzle by showing that it is consistent with findings on loss aversion

  • Demonstrates that three factors drive valuation and stock price: earnings, long term growth, and interest rates

Understanding the stock market is simple. By grasping the simplicity, business leaders, corporate decision makers, private equity, venture capital, professional, and individual investors will fully understand the system under which they operate, and find themselves empowered to make better decisions managing their businesses and investment portfolios.

Note: The ebook version does not provide access to the companion files.

Table of Contents

  1. Cover
  2. Series
  3. Title Page
  4. Copyright
  5. Dedication
  6. List of Figures
  7. List of Tables
  8. Preface
    1. EVOLUTION OF A THEORY
    2. OVERVIEW
    3. HOW THIS BOOK IS STRUCTURED
    4. AS YOU BEGIN
  9. Acknowledgments
  10. About the Author
  11. Chapter 1: Understanding the Simplicity of Valuation
    1. RATES, COMPOUNDING, AND TIME VALUE
    2. WHY TIME VALUE MATTERS FOR THE STOCK MARKET
    3. VALUING A PERPETUITY
    4. CONSTANT GROWTH EQUATION: THE KEY TO UNDERSTANDING THE STOCK MARKET
    5. NOT THE FIRST TO TRY THIS
    6. WHY GROWTH RATE AND COST OF CAPITAL MATTER
    7. P/E RATIO EXPANSION AND CONTRACTION
    8. CAPM, RISK PREMIUM, AND VALUATION
    9. EQUITY RISK PREMIUM
    10. IMPACT OF RISK PREMIUM ON VALUATION
    11. CHAPTER RECAP
  12. Part One: Exploring the Risk Premium Factor Valuation Model
    1. Chapter 2: The Risk Premium Factor Valuation Model
      1. THE RPF MODEL IS SIMPLE, BUT DOES IT WORK?
      2. ESTIMATING THE RPF
      3. POTENTIAL CAUSES FOR SHIFTS IN THE RPF
      4. POTENTIAL WEAKNESSES IN RPF THEORY AND METHODOLOGY
      5. ADJUSTED RISK-FREE RATE
      6. COMPARISON TO THE FED MODEL
      7. CHAPTER RECAP
    2. Chapter 3: Solving the Equity Premium Puzzle
      1. LOSS AVERSION
      2. LOSS AVERSION AND CORPORATE DECISION MAKING
      3. ATTEMPTS TO SOLVE THE EQUITY PREMIUM PUZZLE
      4. IMPACT OF INFLATION ON VALUE
      5. BACK TO LOSS AVERSION
      6. OUR REPTILIAN BRAIN
      7. CHAPTER RECAP
    3. Chapter 4: The RPF Model and Major Market Events from 1981 to 2009
      1. EFFICIENT MARKET HYPOTHESIS
      2. HOW THE RPF VALUATION MODEL EXPLAINS BLACK MONDAY
      3. 2000 “DOT-COM” BUBBLE: RPF MODEL SUGGESTS SIGNIFICANT BUBBLE FOR THE S&P 500
      4. HOW THE RPF VALUATION MODEL EXPLAINS THE 2008 TO 2009 MELTDOWN AND RECOVERY
      5. MARKETS MOSTLY EFFICIENT AND RATIONAL, BUT PRONE TO MISTAKES
      6. CHAPTER RECAP
  13. Part Two: Applying the Risk Premium Factor Valuation Model
    1. Chapter 5: Application to Market Valuation
      1. BEWARE OF INTEREST RATES
      2. EXAMPLE: APPLICATION TO THE MARKET IN LATE SEPTEMBER 2009
      3. WHY THE SOURCE OF GROWTH MATTERS
      4. CHAPTER RECAP
    2. Chapter 6: Risk-Adjusted Real Implied Growth Rate (RIGR)
      1. ANALYZING INDIVIDUAL COMPANIES WITH RIGR
      2. RIGR ANALYSIS OF APPLE AND GOOGLE PRE-EARNINGS ANNOUNCEMENT
      3. CHAPTER RECAP
    3. Chapter 7: Valuing an Acquisition or Project
      1. BRIEF INTRODUCTION TO VALUING AN ACQUISITION OR PROJECT
      2. TRANSLATING YOUR WORLDVIEW INTO NUMBERS
      3. SETTING THE COST OF CAPITAL
      4. EXAMPLE: UTILITY ACQUIRING A RISKY ASSET
      5. SELECTING THE INVESTMENT FORECAST TIME HORIZON
      6. THE ALL-IMPORTANT TERMINAL VALUE
      7. CHAPTER RECAP
    4. Chapter 8: Case Study 1
      1. CALCULATING ENTERPRISE VALUE AND STOCK PRICE
      2. SCENARIO ANALYSIS
      3. CHAPTER RECAP
    5. Chapter 9: Case Study 2
      1. CHAPTER RECAP
    6. Chapter 10: Using the RPF Model to Translate Punditry
      1. READ CAREFULLY, THEN ANALYZE
      2. WHAT HAVE I GOT TO LOSE?
      3. BEWARE OF OVERSIMPLIFICATION
      4. CONFUSING HEADLINES AND MISGUIDED BLAME
      5. ALMOST NAILED IT
      6. GRAHAM AND DODD
      7. THE WRONG DISCUSSION
      8. DUMB MONEY AND BUBBLES
      9. THE RIGHT DISCUSSION
      10. CHAPTER RECAP
    7. Chapter 11: Using the RPF Model for Investment and Business Strategy
      1. ESTIMATING FAIR VALUE: HOW TO IDENTIFY AND EXPLOIT BUBBLES
      2. BEWARE OF RPF SHIFTS
      3. INVESTING IN INDIVIDUAL COMPANIES
      4. REPORTED EARNINGS CAN BE MISLEADING
      5. HOW TO APPLY THE RPF MODEL TO DAY-TO-DAY BUSINESS DECISIONS
      6. CAPITAL STRUCTURE AND RISK IMPACT COST OF CAPITAL
      7. OPPORTUNISTIC ADJUSTMENTS TO CORPORATE CAPITAL STRUCTURE
      8. CREATING A SENSE OF URGENCY
      9. AVOIDING VALUE DESTRUCTION
      10. VALUE CREATION
      11. KEY MERGER-AND-ACQUISITION VALUATION CONCEPTS
      12. INFLATION IS THE ENEMY OF VALUE
      13. FINAL THOUGHTS
  14. Appendix A: Mobile Apps: The Wave of the Past
    1. MOBILE PAST–RIM MISSES THE NEED FOR APPS
    2. MOBILE TODAY–THE NEED FOR APPS
    3. LOOK BACK TO SEE AHEAD–MOBILE WILL FOLLOW PC EVOLUTION
    4. IMPLICATIONS–THE END OF WALLED GARDENS
  15. Appendix B: Technology on the Horizon: What if Moore's Law Continues for Another 40 Years?
  16. Appendix C: A Simple and Powerful Model Suggests the S&P 500 Is Greatly Underpriced
    1. RISK PREMIUM FACTOR VALUATION MODEL
    2. WHAT IT MEANS TODAY
  17. Appendix D: S&P Index Still Undervalued
    1. WHAT IT MEANS TODAY
  18. Appendix E: 30 Percent Value Gap in S&P 500 Closed by Rise in Treasury Yields, Price
    1. HOW DID THE GAP CLOSE?
    2. DEVELOPING YOUR OWN FORECAST
  19. Appendix F: Making a Case for Salesforce.com Valuation
  20. Glossary
  21. Notes
  22. PREFACE
    1. CHAPTER 1
    2. CHAPTER 2
    3. CHAPTER 3
    4. CHAPTER 4
    5. CHAPTER 6
    6. CHAPTER 7
    7. CHAPTER 8
    8. CHAPTER 10
  23. About the Companion Web Site
  24. Index