ASWATH DAMODARAN’S blog is only five months old, but it is already gathering a posse of followers. In this his 44th  post he discusses the implications of the current crisis on corporate finance.

a. In investment analysis: I see a shift away from expected value and base case valuations that have dominated financial analysis for the last few decades to more probabilistic approaches. Since both the data and the tools (Crystal Ball, @Risk etc.) are accessible and available now to most of us, I think this shift is long overdue.

b. In risk and hurdle rates: For the near term, I see a move towards higher risk premiums for both equity and debt, reflecting recent history and changes in risk aversion. In the long term, I think that we have to become more dynamic in our assesments of risk parameters and premiums, since the assumption that these numbers don’t change much has clearly been shaken. Put another way, we have to accept the fact that risk premiums can change quickly even in developed markets and even more so in emerging markets.

c. In capital strucure: If debt represents a trade off between tax benefits on one side and expected bankruptcy costs on the other, the last few months have clearly tilted the scales away from the use of debt. The probability of distress and the cost of distress have both increased, particularly so for large companies where the notion that capital markets would provide needed funds is no longer universally accepted. I expect to see debt ratios decrease as companies retool and a less cavalier use of short term financing to fund long term assets.

d. In dividend policy: In the short term, companies will value liquidity and cash balances will go up. In the long term, the events of the last few months will make companies even more wary about instituting and increasing dividends (because of the instability and unpredictability of earnings) and I would not be surprised to see even more of a shift towards flexible cash return policies (stock buybacks).

via Musings on Markets: Corporate Finance – post crisis.

Damodaran’s blog is now on my reading list, though the goldmine that is Dam Online remains higher on that list.

Off the cuff thoughts on the above

Probailistic approaches are fine as long as you use appropriate distributions which appropriately weigh fat tails. That is where there may be room for improvement in Dhando style tools/approaches. From Buffett to Sperandeo, many investors and traders have profited by using probabilities. Probabilities remain an essential tool to utilise.

Risk and Hurdle Rates
Amgen was among a slew of companies raising debt at improving levels in the last month. “The 5.70 percent coupon on Amgen’s new 10-year issue compares favorably with the 6.15 percent coupon on the company’s last comparable issue that priced in May, 2008.” read more
I must check if Amgen are rolling debt and if so what is the increase and if it is new debt what it is for.

Capital structure
I need to verify what the debt ratios are for non-finance companies, where that stands historically and current direction and strength.

Dividend policy: ”In the short term”, say no more, just be aware of it. Short term opportunity may arise if some CFO’s decide this is the time to increase dividends within cash flow bounds. I can think of both sensible and self-serving reasons for a CFO to increase dividends.

S&P dividend results are out. Dividend growth has been slowing and only manged to just hit a new high in 2008. Thelong term dividend history is why I don’t worry about the short term dividend policy.
Dow at 11% dividend yield and HOG at 10%.

The S&P November Market Snapshot paints a dim picture for dividends; however, more companies are still raising than lowering and the report doesn’t break out financials.

 
Reuters have been featuring this photo of a model dressed as the Virgin Mary. I can see why the Catholics in Chile were getting upset. Perhaps they can take small comfort in the thought that the image has momentarily raised the global profile of the Virgin Mary.

Related posts:

1. The Greenspan Put and Behavioral Finance