Duff and Phelps Replaces Ibbotson as the Lead Provider of Valuation Resources
Within the valuation community, there are different variations of how to calculate the cost of equity capital (ke) while utilizing the income approach. A key portion of the cost of capital is the valuators judgement. The data sources that have been utilized have growth in complexity as the profession of business valuation has grown and the need for objective data has increased.
Since 1977 the valuation community has, for the most part, universally used the Ibbotson SBBI Valuation Yearbook to extract market premium and size premium data. This data went back to 1926 to develop the long term perspective of the stock market to eliminate shorter periods of volatility and stability. Informal surveys have suggested that 90% of the professionals that value private companies utilize the Ibbotson data.
The Ibbotson handbook was owned and produced by Ibbotson Associates – a private firm owned by Roger Ibbotson whose research ultimately became the Yearbook of the Cost of Capital and the Valuation Edition. In 2000, Ibbotson Associates was acquired by Morningstar. Morningstar is a leading provider of independent investment research in North American, Europe, Australia and Asia. Morningstar also publishes information from Duff & Phelps is providing the financial services industry with the new valuation handbook. Duff and Phelps is a premier global valuation and advisory services firm that has been providing such a service since 1932. Their cost of equity data includes market data from 1963 to the present day. In 2014, Morningstar discontinued Ibbotson now the valuation community will be forced to utilize the Duff and Phelps data going forward.
While there are a few key differences between the two publications, not limited to the number of years of data that the publications utilize, we must understand that the ultimate source of the information is the same market. Properly utilized, either source should generally yield the same valuation conclusion of closely held business. However, it is still crucial to understand the changes that have become the precedent in the valuation community.
A significant debate between users of both involves the time period that is included in the two data sets. The argument against the original Ibbotson time period is that it includes a time period around World War II where the United States government fixed market rates in an attempt to regulate economic conditions under irregular times of war. This bias is commonly known as the World War II bias. The Duff and Phelps data does not include the World War II time period and therefore some analysts believe it to be more pure and normal. However, the question then becomes what is normal? Between 1926 and 1963 – the period included in Ibbotson and not Duff and Phelps, there were the Roaring 20s, the Great Depression, World War II, the Korean War, and Eisenhower. Is ignoring these events appropriate? Since 2008, the Federal Reserve has kept interest rates at near zero to keep the so called Great Recession from becoming a second great depression. Is this normal? There is no definitive answer to these questions
Another major difference between Ibbotson and Duff and Phelps data is the way the two sources breakdown size premiums. Ibbotson breaks down size premiums into 10 size ranked deciles, including a further breakdown of decile 10, based on size of market capitalization. Duff and Phelps breaks down size premiums into 25 size ranked portfolios using 8 different measurements of size. Duff and Phelps allows the appraisers to focus on financial variables that may be more closely associated with the subject company.
A cost of equity capital can be calculated many different ways and certain determinations must be made. When we analyzed the differences between the using the Duff & Phelps data versus the Ibbotson data, we found an approximate 1.28% difference when we calculated the capitalization rate using the two data sets. However, the cost of equity capital is a concept that is crucial in the accuracy of the valuation process and essential to understand. The Duff and Phelps data will be used universally by valuation professionals going forward. Even though the data and assumptions are different, it doesn’t mean that the valuation conclusions should deviate from accurate results.
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Randall M. Paulikens, CPA/ABV/CFF/CITP, DABFA, Partner 609-520-1188 [email protected] |
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Travis Gerstacker 609-520-1188 [email protected] |
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