Investing in capital asset valuation

For far too long, more as a function of the latent external global perspective on debt and deleveraging as a result of an inordinately long recovery in the financial markets, key policy rates, those that determine such mundane matters as bank-savings rates, have been sorely dismal.

For an economy with traditionally low savings rates as well as a public slow to mature in the ways of modern-day banking, still wallowing in mediocre financial intelligence and severely afflicted with relatively anemic disposable incomes, such dismal rates do not bode well. Not only must capital formation and the sourcing of funds for growth be more reliant on equity but the dismal levels of savings rates also naturally force investors elsewhere, away from banks and away from relatively risk-free investments.

Absent financial sophistication and wary of derivative or fad financial products, the basic instruments in a portfolio remain either debt or equity-based. Debt as formed from financial institutions and creditors like banks. Equity, from the capital markets.

Bank-savings rates are, unfortunately, so insignificant these days that they cannot be counted in a single finger or even merit a whole number as a measure. Even the much-ballyhooed Special Deposit Account created to offer savers a better alternative on one end and provide the state treasury longer and firmer fund sources, has been pulled out of commission as government, in the aftermath of the global financial debacle, soon realized that the product had been too expensive as global rates continued their descent well into the nether regions.

Simply look at the kind of returns offered by the traditional deposits. One might think that money would best be spent than saved. Here’s why.

Simply factor-in even the most benign inflation rate. To compute, multiply the bank savings rate by (1 – i) where i equals the inflation rate. Immediately, returns fall and nearly vanish in most cases. In others, the negative net returns one might derive from the arithmetic virtually rob savers of the value they thought they might earn in that big and bold bank with the slick and glossy ads, the celebrity endorser and the institutional spin that declares them as partners for growth.

For the risk averse, however, the capital markets are literally where one can lose more than the shirt on one’s back. Principal has no protection and risks are open to a slew of variables. Whim and wiles count. As do nebulous market sentiment, bravado and fears. Against such spectrum, many investors still follow the most simplistic methods of analysis from the Price Earnings Multiple to innocently relying on sound-byte analyses from telegenic market analysts.

There are better ways to gamble. For investors willing to do the arithmetic, the capital asset pricing model (CAPM) provides an expandable multidimensional formula that allows investors to consider not simply alternative investment avenues and the environment through which an option is offered but by expanding the formula to include extraneous, albeit critical, costs a better analytical model can be derived.

The underlying foundation of the formula is risk. A good baseline would be to obtain the comparable risk-free rate set as a minimum. The published Treasury Bill (T-Bill) rates would do just fine.

Henceforth, risks start heading north. When one chooses a desired stock and Googles its beta coefficient, the beta signifies the relationship of that stock to the market environment. The closer to 1, the higher the relationship. A stock with a beta below 1 would be less risky while a stock with a beta over 1 would be riskier.

It’s a neat way to compute for value considering that other factors can easily be slipped into the equation by adding the beta for critical factors as GDP or forex fluctuations.

Doing the math helps. And investing a little time and effort in CAPM is a risk worth taking.