CAPM calculator

The capital asset pricing model answers one question: what return should someone require for holding this stock rather than something risk free? It starts from the government bond yield and adds compensation for taking equity risk, scaled by how much of that risk this particular stock carries.

Beta is the scaling factor. A beta of 1 means the stock has historically moved with the market, so it earns the market's premium. A beta of 1.5 means it has moved half again as hard in both directions, so it earns half again the premium.

The model is old, widely criticised and still the standard starting point, largely because the alternatives require more assumptions rather than fewer. Use it as a first estimate and a sanity check, not an answer.

Cost of equity = Rf + beta x (Rm - Rf)

Rf = risk-free rate      Rm = expected market return
(Rm - Rf) is the equity risk premium

A 4% risk-free rate, an expected market return of 9%, and a stock with a beta of 1.2.

1. 1The equity risk premium is 9% - 4% = 5%.
2. 2This stock carries 1.2 times that: 1.2 x 5% = 6%.
3. 3Add the risk-free rate back.

• This becomes the cost of equity in a WACC calculation, and through it the discount rate in a DCF.
• Beta below 1 produces a cost of equity below the market return, which is the model saying a steadier business deserves a lower hurdle.
• A negative beta is unusual but not an error. An asset that rises when the market falls is worth holding at less than the risk-free rate, because of what it does to a portfolio.

• Entering beta as a percentage. It is a multiple: 1.2, not 120%.
• Taking a published beta at face value. It is measured over a chosen window against a chosen index, and both choices move it.
• Using a long-run historical market return during a period when the risk-free rate is far from its historical level. The premium is the part to hold steady, not the total.
• Believing the precision. A cost of equity is a range with a number written in the middle of it.

What each of these inputs actually is, where it comes from in a filing, and where it misleads.