Michael, while I agree that book value is no longer a meaningful measure for most businesses (it is still a good measure for financial firms), that hardly supports the leap in logic to it being equally reasonable to dismiss the risk premium on equities. Sure, if you stretch out the holding periods and measure returns over every 30 year period this century (1900-1930, 1901-1931, etc.), the volatility of equity returns would look rather small. But to use that to argue that risk premiums should shrink to zero is ridiculous.
The risk premium compensates for volatility over much shorter real world holding periods. Don't most mutual funds turn over their entire portfolios every 1-2 years, some even faster? Don't most investors need to have a reasonable measure of intermediate term liquidity (you might keep some assets very liquid for emergencies, but you still might have to liquidate longer term holdings for an extended illness in the family or to pay your kid's tuition in a couple years). It is volatility over these shorter periods that makes equity investing risky relative to bonds or T-bills.
Also, risk premiums are generally measured over treasury rates, not "risky" debt like corporate bonds. And, on treasuries, I don't think anyone advocates using 30 year bonds as their "risk-free" rate. Some might use T-bills as the market value of the principal fluctuates very little with changes in interest rates (making it less risky than notes or bonds), while some might argue that intermediate term notes better match the typical time horizon of most equity investors. Personally, I'd tend toward using T-bills, perhaps one year ones. Surely, you don't think there shouldn't be a premium in average equity returns over the risk-free rate?
Since you brought up corporate bonds, I also don't buy the argument that the distinction between equity and debt risks have become blurred. Debt holders always have a priority claim over both the assets and the cash flows of the business even if it takes all of them to pay the debt. Equity holders get paid if, and only if, there is something left over. In fact, one can price the equity of a leveraged firm as an option on the firm - a call with a strike price equal to the face amount of the debt and expiry being maturity of the debt. Surely an option is riskier than the underlying security, no?
Anyway, I think (based on what one said on CNBC) those authors are full of sh!# and that it is a sign of the times that such a book is being published and touted on CNBC. They will sell many copies and speak at many b-schools, and they will eventually be dismissed as opportunists and charlatans (or simply forgotten).
Regards,
Bob |
