Session 6 (Val Undegrads): Implied Equity Risk Premiums and First Steps on Relative Risk

okay folks I think I will ask the question for the last time and then I would stop nagging you how many of you have not picked a company yet notice how I phrase the question differently this time how many of you have not picked a company yet to value okay I'm not going to jump down your throat I just want you to pick one soon right don't don't don't hold off much longer because were six sessions in so today I want to continue our discussion of equity risk premiums and in particular I'm going to introduce an alternative to the way in which most people estimate Equity risk premi do you want to remind me again what did we talk about how do most people estimate Equity risk premiums past right look at historical risk premium last 50 years last 100 years what's wrong with doing that first it's backward looking rather than forward looking things could have changed second it is noisy remember the standard error and third if you have a market like Vietnam you can't even do it right it's just not there so today I'd like to offer you an alternative and when I do it it's going to sound you know look fancy but I'm going to set up the intuition behind what I'm going to do by setting up a very very simple example so I'm going to pick one of you so let's say you're going to be my guinea pig okay let's say you are looking at an investment where you're guaranteed $1 a year every year in perpetuity and don't come back and say I'm not going to live in perpetuity your your children your grandchildren your great- grandchildren would get it and you're optimistic about the world not blowing up okay $1 a year in perpetuity how much would you pay for this investment today 50 bucks okay when you pay 50 bucks you're essentially settling for how much is the risk free rate 2% you okay with that what what can you yeah so L you'd ask for more you'd pay more that'll make it even lower what what's the t-bond rate right now 4% so no we're looking at 4% so you essentially if that is risk- free I would say you know 25 right so in a sense because it's gu gued you're going to pay 25 bucks and if you pay 50 bucks you're effectively getting 2% if you pay the more you pay the lower your return is so let's file that away what you pay is telling me a little bit about your expected return here now let's extend the idea since know now let's suppose I gave you the same investment but this time you're getting a dollar a year every year but it's not from a guaranteed investment but from a risky investment about is risky as the average risk stop so you see the difference right he was willing to pay $25 for a get guaranteed investment and accept a return of 4% would you pay less or more way less way less okay give me a number okay if he says that he's willing to pay $10 for this investment has he given away his expected return on this investment what's is expected return 1 divid by 10 10% you've given away your Equity risk premium right 6% is your Equity risk premium do you see what I'm saying if you tell me how much you pay for things implicitly you're telling me what your risk premium is and that is the Insight we're going to use today to break out what the equity risk premium for the market is do we know what people are willing to pay for stocks right now yeah there's a price out there I can look at the index do we know what the expected we don't but we can estimate what the expected it's not going to be as simple as this a dollar a year every year but I can give you what the cash flows are and I'm going to solve from those numbers what you're expected to turn is and use that to get an implied Equity risk implied because it's implied in the prices now what drives the equity risk premium is how risk averse you are right so as I talked yesterday about or Monday about how as you age risk premiums go up lots of different reasons you got responsibilities you get older and wiser or or more scared whatever it is but there is evidence that is people you know there's also evidence that risk premiums vary based on whether you're male or female I know we're entering dangerous territory here but are men more risk averse than women or women more risk averse than men it depends young men are less risk ofs than young women I can attest to that I have three boys and a girl they're all grown up now and I always could sleep and my daughter took the car out my sons had to stay awake till they got home young men take not and not just less risk ofs they take some really bad risks in fact you know a few years ago when Society General had this um huge trading Scandal there's some Trader lost like five billion I made a suggestion have any of you guys been in a trading room of an investment Bank you look around there's a disproportionally large number of one subset of people young man right if you were going to create a group of bad Risk Takers this would look like it right but young 25y olds in front of a the the God knows what kind of so I made a suggestion that people didn't take take seriously I said there's a very simple check on bad risks taken by this group of people the only person who can check a 25y old or 23 year old male taking bad risk is his mother so I suggested that they hire every Trader's mother pay them 100,000 to sit behind the trader look over the show what are you doing now that looks really risky don't do it now you say that'll cost us a lot of money but you save it two B there will be no $2 billion trading loss if your mother's sitting standing behind you sitting behind you saying don't do that there there's clearly an effect as people age that risk ofver and we talked yesterday Monday about the Dem demographic bomb that is going to go off it's already gone off in Japan and Europe that might potentially go off in China you know what this implies for Equity risk premiums then right if people are getting older investors are getting older Equity risk premiums are going to rise if Equity risk premiums rise what does it do to stock prices they're going to go down there is a long-term push towards lower stock prices in countries with aging populations so let that all filter in because it effectively means Equity risk premiums are this Dynamic number that affected by everything happening around you and they're going to play out so let's go back to where I left you the not we're talking about I left you with you know Emerging Market exposures and how to estimate it there's one thing I did not mention which is you know we talked about how to estimate the equity risk for a company and I said you can use Revenue weights you can use production for oil company I said look at where you get the oil but in both those approaches I'm trying to get the equity risk premium as a weighted average of where you operate there's another approach and I use it very infrequently I'll tell you what kinds of companies this would be where if a company has an exposure in one risky country and I want to focus in just on that country rather than bundle it together like I did for embri and put it into the equity risk premium I leave that country risk premium separate in the case of for Brazil and as estimate how exposed the company is to that country's risk i c i concocted a measure called Lambda notice the word I use concocted doesn't derive no deep thinking involved called Lambda to try to capture that risk say why do you call it Lambda discover that if you attach a Greek alphabet to things it adds a layer of sophistication that people don't want to push back against why do we call Bas betas why not B but Bas you there must be something magical behind it a Lambda measures your exposure to Country risk and here's how it works if you believe in the Lambda approach you're trying to a high Lambda means you're more exposed to Country risk and here are some of the things that might affect your Lambda and you can add to this list if you want the first is well you use risk management products there are some companies that use Insurance derivatives you could lower your Lambda by doing that so I want to know what you do the second is if you're a company viewed as being in the National interest God help you your country risk just went up because it means the government has a very direct interest in how you run so I'm going to look at that I'm also going to look at what your revenues everything I looked at for my traditional calculations but now I'm focused on getting this Lambda a Lambda looks very much like a beta Lambda 1 means you're as exposed as the average risk company in that market risk a Lambda less than one means you're less exposed the typical company in that market a Lambda above one means you're more exposed so I'll give you my most simplistic way of estimating Lambda I talked about embra in the last class Brazilian Aerospace company that gets almost all of its revenues outside Brazil so I gave you the intuition should be less exposed to Brazilian country risk than another Brazilian company that gets most of its revenues from Brazil in this case I'm going to pick the other end of the extreme company called emle a phone company in Brazil that is absolutely completely locked into Brazil as a country they can't even leave they're know regulatory requirements so you have two extremes here embria that gets 7.62% of its do I have EMB no sorry I've used tar Motors and TCS but you can use Embraer and EMB I'll stay with that Embraer got about 3% of its revenues from Brazil EMB got a 100% of its revenues in Brazil the Lambda for embal was like 1.7 the Lambda for embri was like4 04 basically reflecting just revenues here I've taken another pair of companies from India CS which is part of the tataa family group but it's a Outsourcing company that gets 7.6% of its revenues in India and T motors which gets 91% of its revenues in India both Indian companies but the Lambda reflects the fact that one company gets very little generally the Lambda approach as I said I use only if it was because if I have 72 countries and I have to estimate 72 lambdas I'm going to go crazy so for companies with lots of country exposures go with the approach I talked about in the last session take a weighted average of where this company does business either with revenues or production but if you have a company with a single country you're worried about whether it's turkey Nigeria and you want to think about Lambda more seriously that thinking can I think give you insights into the risk you worry about in this specific company one final point about lambdas you know if you don't know the revenue thing is a very simplistic measure there's actually a market based measure of Lambda that you can try you know how we estimate betas right we're under regression of stock against the market index the slope of the line is debated measures how much your stock moves relative to the market you can actually estimate Lambda by looking at a traded instrument I'll take Brazil as an example Brazil's country risk es and flows and there are country bonds issued by Brazil the dollar denominated bonds that are traded and you know what drives those bonds partly what happens to US dollar interest rates to begin with because that the other is country Every Time Country risk increases that Brazilian dollar bond rate goes up so in this graph here's what I did I took the Brazilian dollar Bond and ran a regression against EMB so if you look at there's EMB there's a return so basically I'm taking the return of the stock running against the dollar Bond so if I have a company that's exposed to Country risk you should see its stock react much more to what the dollar bond is doing because it's more sensitive so the slope of the line like I did for beta become the Lambda for the stock for embri that Lambda was .27 what does that tell me embri is not that exposed to Country RIS for every 1% increase in the dollar Bond there's only a 27% increase in EMB in contrast emle the phone company every 1% change in the dollar in the Brazilian dollar Bond translates a 2% change it's much more exposed to Country risk so in periods where country risk is dropping or increasing you're going to see companies like are less affected than companies like utle and you're going to see this play up across an emerging market so I tend to look at exposure rather than where a company is incorporated but I'll concede most people out there most investors most analysts still think about country risk through the lens of where you incorporate it Brazilian companies Brazilian country risk now remember what we said about intrinsic value you got to take a stand the stand is should I do whatever everybody else is doing because that'll get me closer to the truth or do I believe that this is closer to what drives intrinsic value I firmly believe that an intrinsic value it's where you do business that drives country risk not where you're Incorporated so I let's say you go along with that belief you buy into that makes sense to me I'm going to ask you a question about what kind of investment strategy you can then develop based on that view of the word that will allow you to make money so we will play that out so start thinking about it if I believe that investors are wrong in treating all Brazilian companies alike how do I then take advantage of that market mistake we talked about taking advantage of Market mistakes because the approaches can give you very different numbers in this page I've actually taken and and computed five expected returns remember these become hurdle rates to use all in dollars all start with the same risk rate rate so that is the US dollar RIS free rate in the first approach I basically treat it as just an another Brazilian company and I attach the entire Brazilian country risk premium to it and I come up with the cost of equity of 17% in fact if you if you take these five approaches and you group them together in any approach where I treat it as just another Brazilian company I get 16 17 18% as my discount rate in any approach where I treat them as a company with a lot of exposure in developed markets I come up with n 10 11% cost of play it out right let's assume everybody else is using a 177% let's say everybody's doing discounted cash flow valuation and everybody's using 177% discount rates to Value the company and you use a 10% discount rate what are you going to find you're going to find that the stock is significantly undervalued right because people are going to push the price down and you think that's unfair you shouldn't be punishing this company for being another risky company you ready to set up your investment strategy so help me out if you go to if you apply the strategy out what are you going to do to find your stocks to buy what are you going to do across the bo you're going to go to the riskiest Emerging Market let me get you started what type of companies in those markets are you looking for which are the companies in those markets they're in which get most of the revenues outside the market so it be and Brier in Brazil TCS in India vinom milk in Vietnam basically companies that are in that country but but get a lot of their revenues outside the country and don't be too quick and jump in right now because remember you need to get to make money what has to happen everybody has to come to their censes right saying how do I do that who knows wait for a crisis he's saying will there be a crisis it's an Emerging Market of course there'll be a crisis it's a question of when not whether wait for a crisis because in a crisis what happens everybody sells everything they push prices down across the market buy Venom milk not te as EMB Brier and then hold and pray pray that what happens that eventually the truth will come out the way the truth comes out is the country gets into trouble but this company keeps reporting earnings that look good and at some point in time investors wake up I bought EMB Brier in 2002 or three I don't know remember the first time Lula ran for election in Brazil people basically said it's a socialist everything's going to be private know he going to nationalize everything Brazilian stocks lost 40% of their value including company like Andra and I said that doesn't make sense there's country risk but this is a company that gets 97% of its revenues outside Brazil and that that had a good ending St there other stories I could tell you which had Bad Endings but if you believe that risk comes from where you do business there is a way you can monetize that belief and that's what I want you to think about an intrinsic value think about the right thing to do think about what everybody else does you will feel the urge to do what everybody else does I don't want to be the outlier here and if you go to work at a bank do what everybody else does why do you want to make life difficult for yourself it's not your money anyway but if it's your money you want to take a stand on things you think matter and I think this is something I think we need to take a stand on on where risk comes from conversely if I can sell short you know the companies I would sell short on us companies and European companies that get what most of their money from most of them rning from Emerging Markets because I know there will be a crisis and then these companies will ring their hands and say oh my God I never saw this coming and he said I saw that coming because you had 60% of your revenues in Afghanistan what do you think would happen right so this is about using common sense a risk comes from where you do business not where you're Incorporated now you see companies do all kinds of contortions because the way an Street risk I remember South African mining company and they decide to un delist in Johannesburg which is where they were listed and relist in London and they said why are you guys doing this he said because we want country risk to go away I said it's that easy what do you plan to do next take those mines out of South Africa and put them in the middle of Lancashire your all your risk is still in South Africa putting your listing in London doesn't make that risk go away but people look for these cosmetic things they think that that takes risk because of the way analysts think about risk where you're listed Alibaba was listed on the NASDAQ it's a Chinese company when you value Alibaba you'd be crazy to be using the US Equity risk premium to Value Alibaba so let that kind of so think about it you might not agree with the way I've estimated country risk premiums but if you agree with the way of thinking about country risk is coming from where you do business that's a win as far as I'm concerned any questions on Country risk and how to bring it into your company's valuation so I I'm just finishing the valuation yesterday I was in CNBC and the guy mentioned the mag 7 that's the name they've attached to the seven stocks that carried the market for much of the year so that includes you know Facebook Amazon Netflix not not Netflix Facebook Amazon Apple uh Google and um who we missing invid and Tesla with the two add-ons but the original out of the Fang gam everybody but Netflix but see call them the mag seven so I decided I wanted to Value each of the mag seven that might be your next valuation of the week is you can pick any one I'm going to Value all seven and I was valuing Nvidia and this was the the question that I got stuck on Nvidia is a US company but it's a global chip company its revenues it gets you know all over the world but all of its production comes out of Taiwan semiconductors one Nvidia doesn't make a single chip people don't even realize it they design the chips they tsmc makes the chips for them and I was thinking about how do I bring in country risk here because I'm getting China risk in Nvidia no matter how I dance around this and that has to be in my valuation that's what I want you to start thinking about is where does my company make its stuff where does it sell its stuff how do I bring that risk into my discount so now let me set up this process of thinking about Equity risk premiums because I'm not satisfied with my starting point if it's a historical risk premium I'm already shaky right plus or minus 4% in either Direction that's not a good place to start so in an implied Equity risk premium here's what I'm going to do I'm going to borrow from how we think about expected returns in the bond market remember in your foundations class you learned how to price a bond right you also probably learned about yield to maturity on a bond right I I want to test you on how much of your foundations you remember how do you compute the yield to maturity in a bond do you want tell me how how how would I go about Computing the yield to maturity in a bond I'll get you started you have the price of the bond right what else do you know in a bond what are what are your cash flows on a bond yeah you have the flows that's a yield on a bond yield to maturity is a little trickier right you're close on that you take the coupon which is fix and the face value the yield to maturity is and you solve for a discount rate that makes what the present value of the coupons and the face value it's an internal rate of return for a bond we do this all the time with bonds it's a forward-looking number and if the bond gets riskier what happens the price drops the year to maturity goes up that's how we've always done bonds and I remember in in the mid90s saying why can't I do this with stocks let's play it up instead of buying a bond I'm now buying the S&P 500 that's the price instead of coupons what I hope and pray I will get as cash flows on stocks what are the cash flows I get on stocks I don't get coupons what do I get instead dividends and in the US increasingly BuyBacks and unlike a coupon which is a fixed number dividends and BuyBacks could change over time so I make estimates of what they will be in the future and after I've done that I've got something that looks just like the bond pricing equation I have the level of the index of the expected cash flows and I solve for that discount rate that makes the present value of the expected cash flows equal to the level of the index trial and error I can get there that is a f forward looking expected return so tell me what's going to happen if the market drops by 20% you're going to see the expected return go up just like in a bond price bond price and interest rates every time the market moves your expected return is changing which is the way we want to want it to be right it's Dynamic so here's what I'm going to do I'm going to take you to the start of 2020 and now there's a reason I'm going all the way back this was in those innocent days when we didn't know pandemics could shut the whole world down so it's a preco start of that year January 2020 the S&P 500 was at 3231 so I bought the index to get my expected cash flows I start with what I knew which was the cash flows I got in the last 12 months right that's all I know I know what what did I do that's in the past but I want to project out the future and to project out the future I looked at what an were projecting as for the growth in earnings and cash flows of the index the S&P 500 is the most tracked and followed index in the world so there are analysts out there whose job it is to forecast growth in earnings in the index and they were projecting a growth rate of about 4% in the index I think I'm almost here because here's what I did I took the cash flows the most recent 12 months I grew it at about 4% to get expected cash flows once I get the expected cash flows I have one final loose Cent to tie up unlike a bond which has a finite maturity stocks can give you cash flows forever so the way I brought that in was after year five I said the cash flows will continue to be delivered growing at the same rate as the economy and here I'm going to make an assumption you're going to see me make repeatedly I set that growth rate after year five to my risk free rate remember we talked about risk free rates being proxies for inflation and real growth I'm essentially taking the risk R so I have cash flows the next 5 years cash flows beyond your five growing at 1.92% I know what you paid for the stock so take a look at that equation there's what you paid there's are my those are my expected cash flows in the next 5 years and that's the value of cash flows Beyond year five the only unknown is the discount rate right it's a little messier than doing a yield to maturity it requires you to use the solver or goldseek function in Excel I solve for that and I got an answer of 7.12% you're saying what does that even tell me at the start of 2020 I don't care what you hoped you would make what you prayed you would make what you thought you would make given what you paid for stocks you can expect to make a 7.12% expected return the t- bond rate was 1.92% you're making a premium of 5.2% this is exactly the game we played right a dollar asked you how much would you pay I'm backing out from what you're paying what the equity risk premiums it's an implied Equity risk premium and it is constantly in motion it's changing while we're sitting here the implied Equity risk premium is changing for the US it might not be changing much but we could be sitting in an hour the Market's down 15 15% premiums change all the time and this is like a measure that captures those CH those changes that was at the start of 2020 and I went to sleep comfortably for January 2020 that was my Equity risk premium I didn't know what was coming in February and nobody did at least none of the people in this room otherwise we have a conspiracy theory going on I don't want to turn you in to the conspiracy theorist but we were innocent in terms of what was coming and then of course on February 14th of 2020 the premum was still around 4 point some the the the 5 something per i' computed but February 14 2020 if you remember the Italian government announced that they' found up till then covid was on cruise ships in China was it was out there if you're not going to go on a cruise ship and you're not going to China who cares and then on February 14 2020 the Italian government releases new story that there are a couple of hundred Italians who never been on a cruise ship or to China who had Co and we woke up to a nightmare and the nightmare was not just that you'd Catch Co the entire global economy started shutting down so between February 14th and March 23rd are you getting more scared about the future everybody was I don't know whether you remember what it felt like you were probably still you know what freshman in at NYU say will I ever finish my degree is there any point to finishing the degree I might die any day any I'll just not skip preparing for the class we were all filled with more uncertainty if you had a job you know whether you'd go back to the job of course we were scared and what happens when you're scared you start to charge a higher price for risk take a look at what happened to the equity risk premium in weeks the implied Equity risk for the US went from little under 5% to 8% that's what happens during crisis cash flows don't change in six weeks but the worry you have shows up as a higher price for risk yes going down yeah so during that six week period guess what the S&P 500 de it lost 35% of its value remember this was during a class right people picked companies to value at the end of January if they were on top of it early February if they were late and then 6 weeks later the company had lost 50% their money-making companies all became money losing companies God help with that but nothing you could do about it but in six weeks the price of risk doubled stock and the driver was stock price is dropping now on Monday it talked about Chinese equities losing what 35% of their value in the last month implied Equity risk from in China just shot up by about a couple of percent just in the last 30 to 35 days we can talk about what's driving it where is that fear coming from but clearly something is spooking the market so imply what been Peak what was different about 2020 from I've done this every Big Market crisis I did this in 2008 I I remember that I'll show you that page I the same thing I did between September 12th to 2008 December 31st during every crisis I start Computing the implied Equity risk premium on a daily basis just to keep my head straight because otherwise you're going to freak out you listen to everybody they're panicking this gives you some moing on this is what's happening to the market the difference in 2020 in 2008 in 2008 Equity risk BRS did pretty much what this premium did over a 3month period between September 12th and December 31st they went from 4.8% to 8% but in 2008 it took almost four years for them to come back down to where they were before that crisis what was different about 2020 and we can talk about what it is about 2020 they made it a unique crisis is by September take a look at what had happened to the US Equity risk premium it was backed down to where it was on February 14th but you can see the price of risk changing on a daily basis so the advantage of implied premiums is you can constantly monitor what that number looks like Right started 2023 started 2024 the index was at this was just 6 weeks ago 4, 4770 I did exactly what I did in 20120 took the dividends and BuyBacks from the last 12 months notice how much of us company cash flows come from BuyBacks 2/3 of the cash flows at us companies now come from BuyBacks only one third come from dividends and then I projected out the cash flows and at the start of 2024 the the internal rate of return the implied Equity risk premium which I'm going to use to compute the implied Equity risk premium was about 85% at the start of 2024 US stocks are being priced to earn an expected return of 8 half% and if you compare that to the T bond rate 3.88% that difference 4.60% was my implied Equity risk premium for January if you did the you know my if you looked at my Tesla valuation which was January 20 something 21st guess what you will see as My Equity risk PR for the US 4.6% you check out my Nvidia valuation that's going to come out in a couple of days that implied Equity risk frame is going to be 4.5% you say what happened I compute this at the start of every month and for every company I value during that month that becomes my base premium it allows me to keep up because that that means if I have something like 2020 happen I'm not stuck with a premium from the start of the year because the number can shift under me so it's an internal rate of return computed so think of it as a yield to maturity for stocks that's what it is using dividends and BuyBacks as replacement for coupons using the level of the index as a replacement for the for the bond price and solving for your irr and using it to come up with the risk premium any questions on implied Equity risk prems yes we never know right when something happens that catastrophic if I ask you why are Chinese stocks down 35% over the last 30 days all we observe are people acting they're selling we say why are they selling it's a mix of things some of them might be selling because of real fear some of them might be selling because they see other people afraid and some of them might be selling because they see other people afraid of other people this is getting layers away but that's the nature of crowds is when people get scared everybody rushes for the exit doors so there might be some originating Factor there's usually some fundamental with Co what was the fundamental that was scaring people the economy had shut down we didn't know when it would open back up and what it would look like when it opened back up I mean people forget how much uncertainty there was about what the economy in fact this was like turning off a gigantic machine ma which had never been turned off in its life before and said please God when I turn it back let it turn back on nobody had any so that was the Co in 2008 what was driving the fear Banks getting into trouble if banks get into trouble it's going to have a spillover effect every big crisis has an originating problem but then that originating problem kind of spins out of control people get scared and that fear feeds on itself yes it's the in fact of all the numbers that's a good question the way I get the growth rate is by looking at analyst forecast of earnings the that's updated once every week okay the but you are right analysts when they get scared often stop updating properly so there was a period for about three or four weeks where they kind of threw up their I don't know what's going to happen they left the earnings of all the numbers that is the stalest number here because you're not getting the daily update every other number is updated every minute of every day so that's the weakest link here is there a standard error around that estimate absolutely so if you ask me is that my Equity risk been 4.6% yes but the standard error on that number is probably plus or minus 2% but I'll take that right what was the standard error on my historical risk premium plus or Min - 2% not 2% so there is that noise in the growth number that is going to cause is equity risk premium to be off sometimes and that's okay as long as you can live with that little bit of noise so I've computed this number live for the last 30 years starting like 93 is when I started but I was able to go back and retroactively do it from 1960 without using any of the benefit of hindsight you know what I mean by that I computed the 1960 premium without looking at because it's not not fair to bring in what happens afterwards you got to act like you were in December 3 so this is a page of what the implied Equity risk premium has look like for us equities going back all the way to 1960 this graph tells you the story of US stocks for the last 64 years let's play it out 1960s what do you notice about the employed Equity risk PR nice stable 3 and a half% the US economy was the global economy the US Equity markets basically r and the world incredibly stable mean reverting time for us equities that was the 1960s 1970s first notice that something's happening right the equity risk premium is jumping we talked about precipitating factors this was not a short crisis this was an entire decade where premiums went up and stayed up what was the precipitating factor for the rise in US Equity risk premiums in the70s the oil crisis the oil but remember the oil crisis played out around the world this didn't happen in every Market this was us specific the oil crisis in the US created inflation and inflation historically has been deadly for equities higher inflation people are worried about where will the inflation go we've actually saw this play out in 2022 look at how terrified people got 197 1978 the employed Equity risk premium in the US hit 6.5% I still remember the you know the Dow was at 750 there were three numbers in the Dow what's it now like 38,000 39,000 750 Business Week had a cover article on our stocks dead which should be an indication when Big Business art you know periodical our stock said that's the time you should load up on stocks because that was the start of one of the great bull markets of all time but take a look look at what happened for the next 20 years there blips either way but the premium is going from 65% and it's de remember premiums are decreasing stock prices are rising in fact in the 1990s at the end of 99 the implied Equity risk premium in the US was down to 2% me try and experiment on you what's the t-bond rate right now about 4% would you be willing to put all your money in equities if I said your expected return expected return not guaranteed expected return was 6% how many of you would put your money in stocks if don't wor there's no wrong answer if you put your money that's that's fine one person this room and that person is the least risk ofers person in the room or the most risk ofers person least risk ofers people most of you are saying 6% that's not high enough that's 2% more than the t- B if I can make 4% guaranteed I need more than 6% on stocks and I could try do a little survey how many of you would accept 8 10 there's a point at which your hand will go up up but at the end of 99 this was the implied Equity risk PR of the market that is the peak of the doom boom and people are talking about how there would never be a recession again I'm serious they said we're in this new age recessions won't happen here and of course there's the bust implied Equity risk Brams pop back up to around 4% stay around 4% for about 5 years and then you get the 2008 crisis and since 200 8 Equity risk premiums globally have stayed elevated and more volatile welcome to globalization you see why globalization pushes up and makes Equity risk more volatile everybody's problem is everybody else's problem that's what surprises me about the Chinese Equity Market belt down is how can the second largest Equity Market in the world have this much trouble without spilling over because that's not been the case for the last 15 years until 2008 I used to compute the equity risk once every year and use it all year and my defense was we in a mature Market mature markets Equity risk premiums don't change that much it's almost like the gods are waiting for you to say that because that's when the 2008 crisis had and since September of 2008 I've been updating those implied Equity risk premiums every month so February number is up on my if you go to the the the the homepage for my my web page is demon.com front page you'll see the updated know the March number will come up the April number I won't push you to use the main number because that might be pushing you too close in your project but try to update the equity risk BRS as you go through it's a base number everything else gets updated for every other country because remember all the other countries build off this base now the other thing you can get out of this graph is an answer to a question that you will I I get asked this all the time maybe you will do at some point in time what do you think about stocks do you think they're going to go up but are we in a bubble he's saying how would Computing an expected return and an equity risk premium allow me to answer that question what's the question that you're being asked are stocks too high or low is 4.6% a sufficient Equity risk Prem right if you say it's too low as in 1999 you saying stocks are too high they have to correct any statement you make about markets can be translated into a statement about the equity risk premium if you tell me this Market is overvalued you're telling me the equity risk premium is too low it's got to go up if you tell me the market is undervalued you're telling me the equity risk premium is too high so you think 4.6% is a higher lower number the only way to look at that is to look at through the lens of History so in this graph I've looked at the T bond rate and the equity risk premum over time and I want you to to take you back two years to start of 2022 start of 2022 the expected return on stocks was 5.75% that's the lowest expected return I've computed in in the 64 years that I've been Computing the expected return the IR you say why would I settle for 5.75% on stocks why were people settling for 5.75% what's the alternative investing in stocks you invest in t bonds and the t- bond rate was 1.5% the long time on the street there was this acronym called tina there is no alternative so basically if you ask people why are you paying so much for stocks the answer is where am I going to go t- builds pay me nothing t- bonds are paying me one and a half% and that was the answer you'd have gotten started 20122 5.75% I know it's lowest in history but my alternative is to make 1.5% see how much that game has changed over the last two years now by in fact in 2022 alone that was in one year that expected return went from 5.75% to 9 almost 9% that's the biggest and 9 9% plus actually it was 5.94% Equity risk premium on a risk- free rate of 3.88% in one year the expected return jumped almost 4% that's scary because you think about pushing up your required return the price has to go down to reflect that 2022 was an awful year for stocks this year we're starting at 88.5% January I think at the start of February that it dropped to 8.3% 8.35% I'm okay with 8% but if that number starts to go to 7 6 and a half five you're starting to worry is is this enough is there a correction coming that looks too low so this then becomes your barometer for what you think about the overall Market I'm not going to ask you for your Market views I'm going to ask you to Value individual companies but the equity risk premium gives you a sense over the market so the equity risk premium is the price of risk in the equity Market when people get scared they push up the equity risk premium in the bond market there's a price of risk as well it's called the default spread so when people get scared they push up the default spreads across the board when people get feeling good they push down the default spreads do you think the same people are in both markets most of the time the people are scared in one market they tend to be scared in the other Market as well so in this graph yes what I did I took the Equity risk that's a red line and I grafted against a default spread on a baa rated Bond I picked one rating so the rating is not changing but the default spread is I'll start with the good news most of the time the two move together why because people get scared they get scared but there have been two periods in the last 65 years where the two have moved in opposite directions and there have been consequences the first is in the late ' 90s late '90s if you take a look at the Equity risk cream drops and drops and drops the default sprit stays pretty elevated in fact in 99 when the equity risk cream hit 2% the default spread on a baaa rated bond which is a pretty safe Bond that's an investment grade Bond was also 2% so question I was asking do you rather buy that Bond or buy stocks say that's a no-brainer i' buy the bond a lot of people still ended up buying stocks question yeah so at the end of 99 something weird had happened and of course a correction there was stocks had become overvalued they corrected and you got through then you get to 2001 and 2002 a different problem opens up the equity risk premium stays high but default spreads start to drop off you know what caused that after 911 Alan Greenspan who was the chair of the FED then said I will not allow the US economy either the hubris of central Bankers I will not allow the US economy to go into recession and for three or four years the bond market was pumped up by money coming in from the FED it pushed down to fall spreads you push down to false spreads what are you doing you're lending money to people with bad credit risk at too low a rate and what happens eventually the thing blows up that was 2008 now what I'm trying to say is most of the time the reason I track these numbers is most of the time one goes up the other goes up 2023 both numbers decrease so I'm okay but I'm looking for am I approaching another disconnect between the two markets because historically when you see disconnects something bad is going to happen eventually when the two markets start to disconnect from each other so Equity risk mean price of risk in the equity Market default spreads the price of risk in the bond market so that's the two big financial asset classes question 19 1978 yeah they that was the start of Paul vuler came in as the chair of the FED to fight inflation there's a year in which stocks started to recover but it took a lot longer for it to show up in stocks than the dead in bonds so basically you're seeing that L but you you're going to see individually as you look for stretches where the two move in opposite directions because that's really what's going to trigger that disconnect so we talked about the two big Financial assets right stocks and bonds what's your asset class that is almost as big as those two but we don't talk about very often sorry derivatives is not even a market right it lives off it it sucks up from an underlying stop real real estate right the real estate market is huge but we don't talk about it mostly because it's not traded for there are reads and real estate companies but most of real estate is not traded it's held as residential real estate many people's portfolios remember the biggest investment they have in their portfolio is their house right is there a price of risk in the real estate market do any do any of you work in real estate or a background in real estate no you know what a cap rate is in real estate what's the cap rate oh you hope get cap rate is what real estate developers use to decide how much to pay for a building so if you have rental income of a million and you have a cap rate of 8% you'll pay $12.5 million for the building basically 8% so basically you're trying to get the million back a cap rate is like a cost of equity that Real Estate Investors require so when they get scared what happens the cap rate will tend to go up you'll pay less for the same building so I decid to bring that into the pict picture as well so think of this as a picture of three markets the red is the equity Market the black is the default spread which you saw in the previous one the green is the risk premium in the real estate market and it looks very strange prior to the 1990s notice the risk premium is negative you're accept you're saying why would I do that now when I learned investing I was told I should invest in real estate in addition to financial assets you know what the selling point was that real estate moves in a different way than financial assets if you own stocks and bonds it's good to own real estate because real estate has a you know mind of its own and in the 1970s this played out right stocks went down bonds went down real estate was the only asset class that went up because it held its own against inflation when you have an asset class that ensures against Risk by reducing overall risk you know what you'll do you'll accept a return much lower than the risk-free rate to be in it because because it offers you Insurance because much of your assets are Financial assets that seems to hold until you get to the early '90s and then something weird happens real estate starts to behave like stocks and bonds something's changed in the real estate market what has changed over the last 30 years in real estate to make it less of that insurance asset class you had in the much of the 20th century to make it behave more like stocks and bonds now but that by itself should know it shouldn't alter the asset class overall where did the name ler who's what do what did leri create he he worked at Solomon he created the very first mortgage back security he securitized real estate you see where this is going right as real estate has become securitized that's good right you can now trade real estate but there seems to be one big negative when you securitize something it starts to behave like a financial asset so if you look at the last 30 years you see that when stocks have a and this is how it's going to play out if stocks have a bad year and you you're an invest you look at your stock portfolio is down 25% your stomach drops look at your bond portfolio it's down 15% and then you look at your real estate it's also down 25% they all seem to have bad years together and good years together it does mean that diversification has become a much more difficult exercise because owning a house doesn't give you the insulation it used to and the risk premium picture kind of brings that home so the price of risk is what we're trying to measure it's going to change all the time it might be correlated across markets I keep this graph live every year just because I want to see how the markets are moving whether they're moving in sync whether they're moving in different directions they're moving in different directions why are they moving in different directions because it's the biggest asset class comparison that I can do any questions un implied Equity risk BRS so does everybody understand the mechanics of what I do right basically I Compu a yield to maturity for stocks and I recompute it every month and that number can go down can go up and most investment Banks and consulting firms still use historical premiums and a historical premium doesn't change right you could be in the biggest crisis but you're looking at a 100e history the 100 Year history is the 100y year history but when I have this argument with investment banks that are stuck on it I'll tell you the argument they give me as a counter and you tell me what you think about it let's say the implied Equity risk premium is 4.6% and the historic premium is 8.3% they pick the stocks versus stbl and there 8.3% first if I am valuing stocks with an 8.3% premium I'm pushing up my cost of equity for every company so here's the defense investment bank's GI they say look it's not important that the premium is right or wrong as long as we all use the same number so if every equity research analyst in your department uses 8.3% as their Equity risk premium and they're doing true intrinsic valuation what's every equity research analyst going to find on every company that they value everything's over everything's overvalued and how long do you think you last as an equity research analy you put a self recommendation on everything so you know what they do they screw up with the numbers they play with the growth rate they play with the cash flows they destroy the entire basis for discounted cash flow valuation because you start with the wrong risk premium you're going to come up with very strange numbers so the reason I push you to stay stay current is not because the market is right but because we're price takers in individual companies if you want to make a market judgment go ahead but an individual companies you want to stick as close as you can to the current implied premium because if you don't your valuation is a joint effect of two things what do you think about the company and what do you think about the market and if you mix the two up I have no idea which is driving your buy or sell recommendation so look at your Equity risk premium keep track with the changes over time because you should be reflecting the world you're in when you value the companies rather than 1928 through 2020 or whatever the historical time period looking at start of every year but so it's almost time for me to work on this I do a paper on on Equity risk premium so I look at historical premiums survey premiums implied premiums it's 120 pages of boredom but I I do it every year just to keep it updated and at the end of the paper I ask a question right which is why do we use equity risk premium because we think they predict the future so good Equity risk premium will be a better predictor of the future so at the end of the paper I have le five or six different ways of estimating Equity risk premium historical implied other and then I look at the correlation with the premium I get with the actual returns I get on stocks over the next 10 years so if you have a good risk premium you need a positive or A negative correlation there what would you like you want a positive High number you want to be a perfect so if you have a good Equity risk pre you should be predicting what the returns will be for the future so first you want a positive correlation and you want as high a number as possible this is through 2022 I'll have to update this for 2023 numbers so if you look across with the with the actual return in the next 5 years okay what's the best best way of estimating remember the higher the number and the more positive the better using the current implied premium gives you the best estimate of what the actual returns will be of the next 5 years the next 10 years what's the worst way to estimate Equity risk previews I mean this is almost perverse right when you use historical risk PRS are actually going in the wrong direction using a high number when you should be using a low number and a low number when you should be using a high number and this is the way people estimate Equity risk fream still is by looking at historical risk premiums so you don't like the theory fine but from a pragmatic standpoint if your job to forecast the future using historical risk prems pushing you in the wrong direction so it's it's about trying to get the best estimate of your cost of equity and the hurdle rate and I think using an implied premium will get you there much better than any of the Alternatives now one final bonus from using implied premiums remember when I talked about Vietnam I said you cannot compute a historical risk premium what's the reason for that there's no historical data can I compute an implied premium for Vietnam let's let's start with the inputs you tell me whether I can get them can I get the level of the index yeah can I get dividends and BuyBacks from last year the last year can I get expected it's a little trickier right because the Vietnamese index doesn't have 100 anals tracking it and projecting it but if I bent the rules and came up with I could get expected cash flows and if I can do that I'm almost home right I can compute an IR based on the level of the index in the cash flows subtract out the risk free rate I an implied Equity risk premium in in 2007 I tried this for the sensex the Indian Equity index the index was at 5,446 the dividend yield on the index was 3.05% you're saying why aren't you looking at BuyBacks in 2007 Indian companies didn't buy back stock was only dividends their expected growth rate was 14% this was tricky for me I could not get an analyst forecast the entire index I had to go Company by company looking for forecasted growth rate and I missed a few companies they weren't projected growth ratees so sloppy I'm going to take what I can get 14% growth rate and the risk free rate in Indian Rupees at that time was 6.76% looks very much like the S&P 500 right there's the level of the index am my expected cash flows dividends and there's my cash flows beyond your five I solve for r the internal rate of return was 11.18% what does that mean in 2007 if you bought Indian equities I don't care what you hoped you would made or pray you make You' make an expected return given what the index was at of 11.18% you subtract out the risk R rate the implied Equity risk premium is 4.42% India and China have always been Troublesome markets to compute Equity risk premiums in for a simple reason now the way I comput Equity risk to the rest of the world is I start with the US premium and I add on these extra numbers implicit there is the assumption that I can move my money around as an investor you know what I mean by that if you have a risky market and the premium is too low what do I do I take the money out of the market and I move it to a safer Market Indian and Chinese investors have basically been penned into domestic markets they have Escape Hatches the Escape hatches have been limited Indian investors for instance and know it used to be they could not invest in foreign stocks they could invest only in Indian stocks do you see what this can do to your Equity risk premium right if you're a domestic investor and you think the Indian Equity risk premium is too low let's say it's 4.42% at the same time the US Equity risk premium is 4.6% he's saying why would I invest in Indian stocks with a lower premium because you have no choice he say what if it goes to four what if it goes to three at some point you know what you're going to do even though you you can't invest in foreign equities you pull your money out of stocks and you move it somewhere else historically in India this used to be gold you know what this is exactly why it's so unhealthy to keep money pegged into a domestic Market you're going to move bubbles around right because the money's got to go somewhere you pend it up you say you can't go out when the correction hits everybody's heading for the exits but they're not putting into other Financial assets they're looking for things to put it in so when you look at an equity risk PR for a market one of the things you could do when you do this domestic is you can see if the Market's gotten out of s the Indian Equity Market is one of the most expensive markets in the world today especially after the Chinese market correction it is probably the most expensive Market it's being driven by an India story it's a story that's picked up legs the India story is legs but not withstanding all the good stuff that will come out of it Indian stocks are too high for me as an investor who has choices but if you're a domestic Indian investor you says should I buy Asian paints which is a very good company but it's a company that you're paying 55 times earnings for it's a mature company I said I'm not going to buy it it's not good for me because I can buy a better bet I can get a better tradeoff by buying a US Stock or a German stock but if only thing you can do is pick across Indian stocks you're almost forced to play the pricing game we talking about pricing game you say look I can't do intrinsic valuation everything looks overv Valu to me I'm going to pick the least expensive of these stocks and that's exactly what happens when you pen people up into a market one final thing and this is a table I update once every year where I take all stocks listed all over the world and I put them into two buckets and I have to make some judgment calls a develop market bucket and emerging market bucket develop market bucket includes most the US Canada Singapore a few you know the few of the Western European market markets not not the southern Europe northern European markets and the Emerging Market includes everybody else and I do an implied expected return in dollar terms for both groups you see what I'm trying to compute let's go back to 2004 when I do the implied cost of equity so I'm doing the irr for all of these companies the implied cost of equity for developed markets was 7.28% the implied cost of equity for emerging markets was 10.55% why am I charging more for emerging markets that're riskier that difference is the premium I'm charging for investing in Emerging Markets take a look at that difference and what happened to it as you go from 2004 to 2012 you see the number drift there's 2008 a little blip but by 2012 investors were pricing emerging market equities and developed market equities as if they were interchangeable and remember the stories I you probably don't you were too young the story after 2008 is the line between development Emerging Markets is gone Emerging Markets are look starting to look like developed markets developed markets like Emerging Markets what's the difference and by 2012 investors were pricing emerging market stocks as if they were develop market stocks and vice versa I think the story has a kernel of Truth it is true the difference between developed and Emerging Markets is far smaller now than 30 years ago even 20 years ago but it's not gone away right we keep getting woken up the fact that Emerging Markets have some special risk that are still there so if you notice what's happened since 2012 you're starting to see the premium come back up but it's still well below what it was in 2004 so there is still a gap between developed and Emerging Markets but it's far smaller than it used to be because there is some truth to the fact that developed markets have a lot of Emerging Market characteristics them central banks that can't be trusted political systems that are unstable and Emerging Markets have many developed Market characteristics and the difference is is narrowing yes many of the original countries yeah each year I actually make my own judgment so basically this comes out of my big data set that I do at the start of every year where I take 48,000 publicly traded companies so the kinds of countries and sometimes a developed Market goes into an Emerging Market 2004 Greece was in the developed Market group it was part of the EU the promise there was they're all part of the EU they're all equally safe by 2012 Greece was in the Emerging Market pile so basically the piles keep shifting and I use the ratings to make that judgment right rather than me sitting there and saying so I think the cut off for me for a developed Market is know A+ or higher is developed a you know anything below A+ it's kind of a very it's a bludgeon I'm doing it across a lot of companies I don't have the Finesse to do it on individual companies but it's just to get a sense of what are investors paying for developed and Emerging Market companies but the reason I'm able to do that is because I have that implied Equity risk so to me it's a versatile tool that I can use right so I intend to actually do the implied Equity risk for the Chinese for Chinese equities over the last month I am curious as to what exactly is going on here I'm curious for selfish reasons because I know the spillover effect is coming and I have to be ready I did during brexit for the footsy that the the the weeks leading up to the brexit election 2016 so whenever you see a big El this will be a good year this year to to do this starting in October for us equities leading into the into the election in November because you're going to see risk and uncertainties build up the equity risk premium becomes your thermometer for how hot is it getting should I you know should I be getting worried yeah so let's at least get started on the third so we've talked about risk free rates if I ask you what risk- free rate are you going to use in your evaluation so what's your answer going to be what risk free R are using an evaluation you haven't picked a company yet or you okay so so that's easy right so what risk free rate are you going to use T bond rate right so risk free rate will depend on the currency you're doing your valuation not the country not the company when I ask you what Equity risk premium you going to use for your company you're going to get the geographical breakdown of operations and try to get a weighted average which leaves you with one input that we haven't talked about which is beta right I don't know about you but I was start bers in a way that still took sucked all the economic intuition out of the out of the word I was asked to run a regression of returns in the stock against returns in the market index the slope of the line I was told was the beta every Finance textbook starts with that equation if you don't believe me open up your Finance textbook there'll be this page it's a way in which most analysts estimate betas is by looking at a regression in fact most of them don't even use a regression you ask them where the bet is come from they say it comes from Bloomberg because they look it up right let's face it once you start working nobody runs a regression you look it up and it's a terrible way to think about betas for three reasons one is when I run a regression of your stock against the market is it forward looking or backward looking by definition has to be backward looking because you look at past returns right so if your company's changed the mix of businesses has changed that beta is no longer the right beta so it's backward looking second it's noisy what does that mean that standard ER I talked about with r I'm going to show you what the standard error is for your beta and you you don't get a ba a number for the beta you get a range and third if I ask you to estimate a bait of a burken stock in September of 2023 you haven't looked at your valuation of the week that's your valuation is burken St even if you don't do the valuation read it's kind of a fun when it's last time you saw barbie enter valuation a and Barbie does affect burken Stock's value if you're looking at the burken stock valuation you say where did we get the beta if I run a regression there's no regression run there are no past returns it's a company that's been a privately owned company I hate regression betas so let me dig a hole for regression Bas bury them deep and next session I'll talk about how what do we replace it with so let me start with the first PR with the regression Bas they noisy they're unreliable this is actually a regression beta I ran for GoPro remember that company what did it do make C make cameras for overactive sharers basically that's what they know so basically people would strap the camera to their head take you on a three-hour hike with them as if you were particularly fascinated by all the pieces of land they were looking at or whatever they were looking at for three hours but for a while it was a huge Growth Company ran a regression and I look for the beta and the beta said you know 1 point you think this is good I have my Beta 1.64 but keep going down to this item that says standard err of the beta 497 if I tell you the regression beta is 1.64 and the standard error is .5 you remember enough statistics to give me a 95% confidence interval on your beta plus or minus two standard error so basically with this regression you can tell me oh GoPro is beta anywhere from 6 to 2.6 thank you for letting me know that was very helpful it'll allow me to get a really precise valuation noisy he say what if my Beta is really precise this looks like a magical regression right if this is a statistics class you'd get a gold medal this was actually a beta page that I printed for Nokia in 2001 so I went to Bloomberg nice thing about having a Bloomberg terminal is you find your company you type in in beta you get this page this looks amazing standard a is 003 close to zero R squ is like 100% why is Nokia's beta so much better than gopro's beta more precise what is it what do I get to to get a beta run a regression of Returns on the stock against Returns on a market index right what was a market index I use for GoPro I didn't never use it in fact I you go to Bloomberg you look up the beta for any us company it runs it against the S&P 500 so when I asked for a beta for Nokia it did what Bloomberg does which is it's very parochial the regression was a noia against the hex I'll make a confession I didn't even know there was an index called the hex I thought was a witches curse until I ran the regression know the hex is the helsinky exchange you say what the heck is Bloomberg doing going to Helsinki Nokia is a Finnish company it went to Helsinki found the Finish index and here in lies a problem I don't know what was in the hex so I took a look and I wish I had not I think in 2001 Nokia owned Finland I'm not kidding it was 80% of the hex so what do you have you're a regression of Nokia against Nokia and you're finding out an awful lot of the time the two move together what did you expect it's a completely useless regression you can't trust regression BAS is when they're noisy you can't trust them and they look good and you can get some really absurd results if something strange is going on with the company remember I talked about GameStop stock goes from 20 to 400 is that a volatile stock it goes to 20 to 400 back to 20 I ran a regression bait of a GameStop around that period And what I got as a beta was minus. 62 what's happening happening what is what do bers measure they measure how a stock moves relative to the market when you have a stock that gets caught up in a meme phenomenon people are buying it or selling it it's nothing to do with the market guess what you've done you've broken the correlation between the stock and the market what you get as a beta means absolutely nothing because of what was happening to the company one final Point all of these betas you notice that right below that raw beta Bloomberg reports an adjusted beta that sounds adjusted right you know the adjusted beta for every Bloomberg estimates beta is for 40,000 publicly traded companies for every single one of these companies the adjusted beta is calculated exactly the same way and I'm going to go back a couple of pages maybe I can oh there it is the old beta page they actually used to show you how the adjusted beta is computed somehow they've seem to have taken it up for every company Bloomberg computes a beta for the adjusted beta is 67 * the raw beta Plus 33 * 1 what so if you're raw so let's see what will happen if your raw ba is 1.8 your adjusted beta will become 1.53 keep track of what's Happening 1.8 becomes 1.53 1.5 becomes 1.33 6 will become 73 what are they doing they're pushing betas towards one what's so magical about one it's the average B they're trying to be helpful and your response is please stop cuz these weights have to be magic weights to work for all 40,000 companies so I decided to call Bloomberg was like 20 years ago not the mayor but the company you know it was a little confusing for a few years there I wanted to find out no how do you why 67 and33 they put me in touch with the beta calculation guy at Bloomberg there is actually a guy at Bloomberg whose life it is to maintain this page can you imagine how exciting his life must be he goes to a cocktail party and says I'm the ba a guy at Bloomberg dozens of people gather around for anecdotes not the guy is pathetically grateful to get a call from the outside world I don't know what they must keep him locked up in a basement room feed him through a hole in the wall and he says I'm so glad you called I have all day to answer your questions I said I don't have all day to ask you questions I was afraid if I hung up the phone too soon he might do something rash after a few minutes of polite conversation I hit him with the question why 67 and33 2 minutes of silence I can hear papers being rustled terminals being turned off and on then 2 minutes later he comes back on says I don't know it was here when I got here I said what he said it was higher 3 years ago it was already here don't blame me I'm I'm not trying to blame you I just don't know where the number comes from next class when we started I'll tell you where because I had to do the research to find where the numbers came from and guess what they're just as useless after I found out that before so if you're going to use a Bloomberg ba at least use the raw ba it's a number that you can actually use the adjusted ba just tells you which direction one is I will see you on Monday