Good Morning Readers,
Looking at the daily volume and return figures of CVS Health verse the market on Friday, left me feeling a bit like an auditor diligently trying to use a Black Scholes model to value an option.
I get that Beta, like the VIX, has not captured risk coherently in years. Especially that of capital structure when discounting good will, but I just want it to work, because it is so easy to use.
However, when analyzing the 14 days when this stock performed the worst over the last year, I notice for 13 of them, the stock performed worse than the market. This led to me have increased concerns regarding the firm’s capital structure. For a stock with such a low Beta, one would expect the exact opposite.
As such, I weighted the FCFF and FCFE models by the company’s tangible asset to liabilities ratio. I believe it to be a better measure of risk than Beta alone for this security, even if does not completely capture the tail risk concerns evidenced by the mentioned trend.
I would suggest those of you using discounted cashflow models to value this security, do the same. With the model setup as such, if the firm over utilizes financial leverage, the risk is reflected in the stock’s price.
Warmest Regards,
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