Hi Sid,
First, I wanted to thank you for your thought provoking comments on the subject. So thought provoking that I dusted off my wife's corporate finance book. And, sure enough, the corporate finance manager's job is two fold; how to raise cash in the capital markets and, then, what revenue generating assets to purchase with the cash.
G&H predict the cost of capital for the equity market will converge near to that of the debt market. Or in G&H terms the risk premium for stocks will approach that of bonds.
You argument, I believe, is well stated in one of your earlier posts:
The problem is that anyone just looking at valuation methods of any kind is forgetting about the REAL connection between the market and the
economy. Stock price levels represent the cost of capital to companies. The higher stock prices go, the lower that cost of capital, and the easier it
is to raise equity capital - IPOs, and additional offerings from companies already public.
On its way to DJIA 36,000 two things would happen: 1)more and more companies would float stock, and the supply of shares (which can
expand infinitely - see the internut stocks) would overwhelm the demand and prevent 36,000 and 2)money raised in these offerings would expand
capacity and cause business competition to overwhelm demand, reducing or eliminating profit margins in those industries where too much capital
has been raised (again, see the internuts, where almost everything is priced at zero these days.)
OK, I see the feedback loop which causes the contradiction. Here's my question - if the cost of capital in the bond market is already much lower than that of the stock market, why don't companies use debt exclusively instead of equity? Why haven't they already borrowed out the ying-yang and caused the scenario mentioned above? (I haven't gotten to that section on capital structure where Modigliani and Miller state that any combination of securities is a good as another) My guess is that debt requires a current stream of interest payments, whereas, dividend can be deferred indefinitely. Is this related, somehow, to the comment by Siegel that the risk premium for debt might increase rather than the risk premium for equities decrease?
Have you thought of contacting G&H directly at their web site?
dow36000.com
Best regards,
Keith |
