I was reading Aswath Damodaran’s blog and much to my surprise found a series of posts on country risk. A lot of the material he talks about overlaps with my last post on currency risk and risk free rate. I did not however find confirmation of what I suggested for currencies which are ‘highly’ overvalued (my suggestion for a global investor was to adjust the fair value estimates, for assumption of a large currency depreciation which is not captured by the risk free rate).
Nevertheless, I think all 4 blog posts are relevant readings for equity investors. Here they are.
- Groundhog day in Greece, Hijinks in Brazil and Market Chaos in China: Pictures of Global Risk – Part I
- Valuing Country Risk: Pictures of Global Risk – Part II
- Pricing Country Risk: Pictures of Global Risk – Part III
- Decoding Currency Risk: Pictures of Global Risk – Part IV
While the posts become quite technical and makes it clear to the reader that a lot of what we do is subjective one key advice from Damodaran is very important. That is consistency in our cash flow assumptions and discount rate assumptions. If our discount rate implies inflation rate of 5% and cash flow assumes inflation rate of 2% we have a mismatch and our valuation could well undervalue the company. The reverse can also happen where we are using a high terminal growth rate number and a low discount rate.