I have been doing some analysis of the ASX All Ordinaries to value some bank stocks recently (particularly NAB which has released it's results). But to value stocks, generally you want to know what the ROE is so you can discount the future cash flows.
ROE is generally found by using the CAPM (or the Capital Asset Pricing Model). This is of the form R = rf + Beta(rm-rf) where rf = Risk free rate (generally 10 year government bond rate) and Beta (the correlation between the return of the Asset you are looking at and the return on the market). rm-rf is generally known as the market risk premium.
Now a lot of this info is available at Yahoo finance/Google Finance, but I always like to check the stats myself to ensure it is correct.
Using OLS regression with ALLORD returns VS NAB monthly returns annualised (from Yahoo Finance), we find the Beta of NAB is 0.36 (fairly low risk). Risk free rate (Aus Govt 10 year bond) at the moment is 0.038. All that is left is to calculate the Market Risk Premium.
To do this, I wanted to find out the historical average of the Market Risk Premium over the decade. Checking the last 10 years of monthly returns (roughly 140 entries), using data on the ALLOrds from Yahoo Finance and historical 10 year bond rates from rba.gov.au, I have found that the average Market Risk Premium is, in fact, negative (-0.03). This is unusual as finance theory dictates that investing the market requires a positive market risk premium. But with volatility in the ASX being what it is, it appears that investors are happy to hold bonds and are paying a premium (in opportunity cost) to do so.
It also explains why some companies are increasing or maintaining dividends at the moment. AS the CAPM is producing sub par returns, the dividend yield is required to boost the return on equity.
For example, for NAB, using CAPM, the Return is a very small 2.63%. This would normally send investors running for the hills. However add of the very generous fully franked dividend yield of 7.16%, investors would be clearing around 9.8% ROE. Not too shabby in this market.
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Dividend represents returns on shareholder's capital, which may be paid in cash or in kind. For instance, a company may pay its shareholders in the form of company's shares.
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