Equity Risk
Whenlookingatthecostofequity,high-growthfirmstendto
bemoreexposedtomarketrisk(andhavehigherbetas)than
stable-growthfirms. Partofthereason forthisis thatthey
tendtobenicheplayers,providersofdiscretionaryproducts
andservices,and havehighoperatingleverage.Thus,firms
likeSiriusmayhavebetasthatexceed1.5oreven2.Asthese
firms and their corresponding markets mature, you would
expectthemtohavelessexposure tomarketriskandbetas
thatarecloserto 1 (theaverageforthemarket).Oneoptionis
tosetthebetainstablegrowthto 1 forallfirms,arguingthat
firmsinstablegrowthshouldallbeaveragerisk.Anotheris
toallowforsmalldifferencestopersisteveninstablegrowth
with firms in morevolatilebusinesseshaving higherbetas
thanfirmsinmorestablebusinesses.Wewouldrecommend
that,asaruleofthumb,stable-periodbetasshouldnotexceed
1.2.
12
Butwhataboutfirmsthathavebetaswellbelow1,suchas
commoditycompanies?Ifyouareassumingthatthesefirms
willstayintheirexistingbusinesses,thereisnoharminalso
assumingthatthebetaremainsatexistinglevels.However,if
your estimates of growth in perpetuity
13 willrequirethemtobranchoutintootherbusiness,you
should adjust the beta upward toward 1.
Project Returns
High-growthfirmstendtohavehighreturnsoncapital(and
equity)andearnexcessreturns.Instablegrowth,itbecomes
muchmoredifficulttosustainexcessreturns.Therearesome