HP-12C CAPM Stock

CAPM: Pricing Risk and Required Return

The Capital Asset Pricing Model (CAPM) gives you the return a stock should be expected to earn, based on how much systematic risk it carries relative to the market. The classic formula is Ke = Rf + β·(Rm − Rf). Here Rf is the risk-free rate, Rm is the expected market return, and β (beta) tells you how much the stock tends to move when the market moves. That (Rm − Rf) piece is the Equity Risk Premium (ERP).

William Sharpe (Nobel 1990), John Lintner and Jan Mossin worked it out between 1964 and 1966, and it's still where most cost-of-equity estimates start. A stock with β < 1 is defensive, the kind you find in utilities and consumer staples, while β > 1 is aggressive, more like tech and cyclicals. In Brazil, Rf is usually the Selic or a 10-year Tesouro IPCA+, Rm is the Ibovespa historical return (around 14% nominal), and the ERP tends to sit between 7 and 9%.

Applications

The cost of equity from CAPM feeds into the WACC behind DCF valuations, the hurdle rates used in capital budgeting, and performance benchmarks like Jensen’s alpha. When a company-specific regression isn't trustworthy, analysts reach for the industry-average betas Damodaran publishes for emerging markets. They'll also unlever and relever beta with the Hamada equation when they need to line up firms that carry different amounts of debt.

FAQ

What if beta is negative? A negative beta is unusual, and it means the asset tends to move against the market. Gold miners and put options sometimes behave this way, and when they do the required return drops below Rf.

Levered vs unlevered beta? Levered beta captures the risk to shareholders with debt in the picture. Unlevered (asset) beta strips out the financial leverage so you can compare operating risk on its own across firms.

Is CAPM still valid? Empirical quirks around size, value and momentum pushed researchers toward the Fama–French 3 and 5-factor extensions. Even so, the single-factor CAPM is what textbooks still teach for cost of equity, and it's what shows up in regulatory rate cases.