The outbreak of Covid-19 has undoubtedly influenced the estimates for future cashflows, growth and risk and therefore the intrinsic value of the regional companies. Therefore, we decided to present you with an update of equity risk premiums for Croatia and Slovenia.
The outbreak of Covid-19 has had a negative impact on the macroeconomic prospects, global capital markets and introduced additional risks to virtually every listed company. As a result, many global as well as regional indices have witnessed a double digit decreases in Q1.
There is no doubt that the mentioned outbreak has influenced the estimates for future cashflows, growth and risk and therefore the intrinsic value of the regional companies. Consequently, for today’s blog, we decided to present you with an update on equity risk premium (ERP) for Croatia and Slovenia. In short, the equity risk premium (ERP) can be explained as an excess return an investor would demand to invest in the average equity over the risk-free rate.
According to Damodaran, to estimate the equity risk premium for a country, one should find the premium for a mature market and add an additional country risk premium, based upon the risk of the country in question. To estimate the mature market risk premium, one has to compute the implied equity risk premium for the S&P 500 index. This is done by calculating the implied expected return on stocks which is then deducted by the risk-free rate (T. Bond rate).
Historical ERP for Developed Markets (1961 – April 2020)
Source: Aswath Damodaran, InterCapital Research
As of 1 April, the ERP for a mature equity market (such as the USA or Germany) amounts to 6.16%, which is quite above the historic median of 3.94% (since 1961) and is converging towards 2008 levels.
In order to calculate the equity risk premium for Croatia or Slovenia, one would, according to Damodaran, have to add an additional country risk premium to the premium for the mature market. Damodaran calculates the country risk based upon the local currency sovereign rating for the country from Moody’s or with the CDS spread for the country (if one exists and/or has sufficient liquidity to be representable). Another way to estimate country risk would be by calculating the spread of the country’s EUR denominated 10 year bond and the Bund, since Bund is deemed as default free.
By doing so, Croatia’s country risk would amount to 2.6%, while Slovenia’s country risk would amount to 0.92%. As a result, the ERP for Croatia as of April stands at 8.76%, which represents an increase of 2.61 p.p. since the beginning of the year. Meanwhile, Slovenia’s ERP stands at 7.08%, which is an increase of 1.43% since the beginning of the year. We believe that the ERP might significantly change in the coming period if both global and regional economic growth shows further signs of fragility.
Equity Risk Premium for Croatia & Slovenia (%) (January vs April 2020)
Source: Aswath Damodaran, InterCapital Research
It is important to note that when calculating the cost of equity for Croatian or Slovenian blue chips, the same (above state) ERP should not always apply just because they are incorporated in the same country. Many of these companies have a significant portion of their operations outside of the country of their incorporation and the risk of operating there should be reflected in the ERP. This can be done by weighting the ERP based on revenues (or another key performance indicator) it makes in each country it operates.
