Estimating the cost of equity applicable in the Maltese context : an analysis

Abstract

Purpose: Cost of equity is the required rate of return by an investor to devote his funds into a particular project or company. The objective of the study is to examine how advisors, stockbrokers and banks perform cost of equity estimation and for what purposes. The aim of the research is to identify market practices in terms of the methodology currently used for such an estimate and how it reflects the local market scenario. Design: Face-to-face interviews were conducted with the 'big-four' advisory firms, stockbrokers and financial managers and banks. Open-ended questions were posed to the parties involved to gather as much information as possible from the three diverse perspectives. General Findings: The study has concluded the predominance of the CAPM for estimating cost of equity in Malta. The pure CAPM formula is fine-tuned to reflect local market peculiarities. This is most particularly evident with the adjustment of specific-country risk, beta peer group comparators, liquidity and small size risk. The research corroborates that cost of equity estimation is most often required for valuations and project appraisal purposes. iv Conclusions: Limited information can be obtained from the MSE and this lack of information may provide distorted data. In Malta reliance on foreign benchmarks for cost of equity estimation is thus inevitable due to these local market limitations. Implications: Local companies reviewed are compared to foreign companies of similar scope and nature. This derived data needs to be adjusted to reflect local circumstances in terms of inherent country risk factors and specific-company risks. The application of subjectivity and judgement is unarguably crucial in this type of analysis.