The Synopsis Dialogue. What is the Cost of Equity?
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Mar 13, 2024 Exploring the cost of equity, absolute vs relative investors, and the punch card idea. Challenging fixed percentage returns in finance and evaluating equity risk premiums. Dichotomy between growth managers and absolute investors, biases in absolute investing, and parallels to relative perceptions. Analyzing opportunity cost, cost of capital, and strategic decision-making in investing using Warren Buffett as a case study.
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Cost of Equity and the Trilemma
- The cost of equity question often leads to circular or dogmatic answers, like the common 10% premium figure.
- This reflects the Munchausen Trilemma in finance: assumptions underpin all proofs, leading to regress or assumptions restated as conclusions.
Relative vs Absolute Investors
- Investors split into relative and absolute types depend on how they measure required returns: relative investors benchmark against markets, while absolute investors focus on total return.
- Relative investors often must stay fully invested, outsourcing capital allocation decisions, impacting alignment with required returns.
Absolute Investing Is Relative
- "Absolute investors" still set return targets relative to benchmarks or historical returns, making the absolute label somewhat misleading.
- Perceptions of proper return are inherently relational, because all things exist in relation to other possible investments.