Who uses CAPM to calculate discount rate when doing valuation? Or most of you do self estimation from historical data? I came across this when I read two different sources teaching this two methods when calculating discounting rate which puts me at a cross road. I rmber reading somewhere that buffett saying something about beta cannot be used in valuation, which capm uses. there are also articles that criticise capm.

Michael T. Nowacki: I don’t use CAPM because the whole theory is based on risk being defined as volatility, which is not true. Risk is the likihood of losing money over the duration of your investment. If it is 5 years, what happens between now and 5 years is unimportant. The only thing that matters is what it is selling for when you want to sell. Invest like you were investing into a private business.

Nelson Lim: thank you for the reply. i dont really know what CAPM is, but im currently finding and reading articles about it. i read that its popular with professionals, thats what had me giving it a second look on what CAPM is exactly. but is it popular because it’s taught in business school where they came from? or do they use it because it works?

Michael T. Nowacki: Some investment professionals use the theory but in practice it is difficult. The theory says the more risk you take the more expected return you should get. Value investors look for low-risk high-return opportunities. Read the article “SuperInvestors of Graham and Doddsville”. It is a speech Buffett gave on efficient markets and CAPM.

Nelson Lim: i have that article printed out, but was put on hold as i was digging what CAPM is really about. thanks Michael for your professional views. i was really stuck at a point where i dont know whether to take the capm route or the other. i guess you’ve taken the capm route out of the equation.

Peter Lim Cheng Teik: Why do you put on hold the article written by the world’s best and richest investor to search for the truth on CAPM when that article would have answered you everything?Furthermore, it’s answered by Buffett himself. Like Buffett says, “Flat earth society will continue to believe the world is flat, regardless of the proof.”

Nelson Lim: because there are a lot of hidden gems out there that can help me. yes, it’s written by the world greatest investor. i agree that i should read it. but im not prioritising by how good the person who writes the article is. i cant read only what he says and ignore what the rest says. i feel that we need to weigh both sides, good and bad.

Nelson Lim: sorry i dont mean to be rude or anything. but i just feel that there’s a reason why people uses it and there’s a reason why people dont use it. and i wanna find out the reason. i believe it will help me understand the situation better by seeing things from both sides.

Michael T. Nowacki: Nelson I will write you a message to your inbox later explaining who successfully uses CAPM and Modern Portfolio Theory (one is David Swenson who runs Yale’s Endowment fund) and why I believe it is very flawed both in theory and in practice. Swenson invests most of Yale’s money into private equity, real estate, and hedge funds to diversify. If you are going to use Modern Portfolio Theory, that is the way to do it. But what average investor can invest into the best private equity, hedge funds, and real estate partnerships?

Nelson Lim: i really appreciate it Michael, i heard shiller talking about him when i was watching one of yale’s economic lecture. shiller talks about swenson growing yale’s fund but did not says how he did it. i understand where you are coming from about average investor not being able to invest and diversify the way he did because of the capital we have. is that why modern portfolio theory is not practical to average investor? because it needs a huge amount of capital which finance students are exposed to when they work in a financial company? i think im getting more grasp of it. thanks again.

Peter Lim Cheng Teik: Why ask again the same question when it’s already answered earlier by Michael. Dumb people will continue to be dumb.

Michael T. Nowacki: Peter I think Nelson is asking because it is so widely accepted among academics and he wants to know why. It is even used professionally by endowment funds, large trusts, and pensions. It is not a bad theory if your goal is to reduce risk, preserve money, have low volatility, and get single-digit returns (i.e. the goal of most endowments and pensions). Also, if you want to be a Chartered Financial Analysis (CFA) you have to know Modern Portfolio Theory. You might not agree with it, but you still have to know it. Buffett doesn’t agree with it completely or use it at all, but he does understand it. I think Nelson is just trying to understand it too.

Peter Lim Cheng Teik: Michael, I know what you mean. But I find it waste of time to repeat again what you’ve mentioned earlier on MPT’s view of risk, which is different from Buffett’s definition of Risk. And I find it waste of time to repeat why MPT’s assumption is flawed.

Peter Lim Cheng Teik: It’s like a person hear, but he doesn’t listen.

Nelson Lim: its okay. dont worry. this is my last post here Peter, you wont see my annoying post here anymore. i admit im dumb, my mum did not give birth to me a genius.