Estimating Cost of Equity for Thinly Traded Companies with Comparable Betas

Summary

The discussion considers how to estimate a company’s cost of equity when its stock trades infrequently and a regression beta is highly uncertain. Rather than relying on that noisy estimate, it proposes using beta information from traded businesses with similar risks. One approach is to calculate a sector beta, weighting comparable companies by revenue, assets, or market capitalization, and then unlever it. Another is to select companies with similar operations and capital structures and use their median or average beta.

The answer notes that an illiquidity premium may also be relevant, but does not explain how to estimate or apply one. It gives no numerical example or empirical comparison of the proposed methods, and the choice of peers and weighting basis remains a matter of judgment. These approaches provide a practical proxy when the target’s own trading data are uninformative; they do not eliminate uncertainty about differences between the target and its comparables.

Key ideas

• A thinly traded stock can produce an imprecise regression beta for cost-of-equity estimation.
• A weighted sector beta can serve as a proxy, with the comparable companies’ betas unlevered for use in the estimate.
• Companies with similar operations and capital structures can provide a peer group for a median or average beta.
• An illiquidity premium may need consideration, though the discussion gives no method for estimating it.
• Peer selection and weighting choices remain important sources of judgment and uncertainty.

Tags

# CAPM with thinly traded companies


# CAPM with thinly traded companies












I have a company that I want to value that is very thinly traded. Its stock has been very erratic. Doing a regression gives me a beta of 0.52 (std. err. 0.43). In other words useless.

What is the best way of estimating its cost of equity?

## Answer by Rob Scott (score 1, accepted)

https://quant.stackexchange.com/a/30953

There are a number of ways you can do this and there is a tonne of material on the web researching this in depth.

The easiest approaches you can take without getting too deep in the mathematics and fundamentals would be either of the following:

- Sector average - Take the weighted average (by revenue, assets or market cap) levered beta from traded companies within the same sector then unlever it to arrive at a pretty good approximate.

- Comparable companies - Find companies with very similar capital structure and operations and wither take the median or average.

There would normally be some form of illiquidity premium added to this however that is another topic all together. Aswath Damodaran explores this topic quite a bit with respect to illiquid companies and calculation of betas for private companies which can be found here and contains many examples using excel.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.