As part of our commitment to providing more reliable and transparent company valuation models, we are constantly adapting our processes and methodologies to changing market conditions and accounting rules. We recently improved the debt spread input to our weighted average cost of capital (WACC) calculation.
This report explains the update, which went into effect on Tuesday, May 18, and the impact it has on our models and Stock ratings.
The Update: Debt Spread Based on Our Credit Ratings
Our Credit Ratings now determine the debt spread used in the cost of debt calculation for the WACC. We no longer rely on ratings from legacy credit rating firms.
This update provides four key benefits to our models:
- Better coverage: we provide Credit Ratings for 2,800 companies vs. ~1,500 from legacy providers.
- Quarterly updates: legacy credit rating firms update their ratings once every few years, usually only when a company requests a new rating.
- No conflicts: we’re 100% independent and have no conflicts of interest with our clients. We aren’t paid by companies or bankers for our credit or stock ratings.
- More reliable: our ratings are based on better data & analytics while legacy fundamental datasets suffer from significant omissions, biases, and flaws.
What is the Debt Spread?
Debt spread is our proxy for the premium over the risk-free rate that a company would have to pay to borrow money. We estimate a company’s marginal cost of debt as the debt spread plus the risk-free rate. More details here.
Impacts on our Models
This update impacts the following calculations in our models:
- Cost of Debt will be updated much more frequently, whenever our Credit Rating for a company changes
- WACC will change due to changes in Cost of Debt
- Economic Earnings will change due to changes in WACC
- Economic Book Value will change due to changes in WACC
- Most values in our discounted cash flow (DCF) models will change due to any changes in WACC
How the Update Impacts your Portfolio and Stock Ratings
Five companies’ Stock ratings changed due to this update:
- Lawson Products (LAWS): from Neutral to Unattractive
- Meredith Corporation (MDP): from Unattractive to Attractive
- Tenet Healthcare (THC): from Unattractive to Attractive
- United Natural Foods (UNFI): from Unattractive to Attractive
- VEON Ltd. (VEON): from Unattractive to Attractive
This article originally published on May 19, 2021.
Disclosure: David Trainer, Kyle Guske II, Hunter Anderson, and Matt Shuler receive no compensation to write about any specific stock, style, or theme.