Yawn. Today, doughnut gem Krispy Kreme
But have things gone too far, too fast for Krispy Kreme's shares? That's always a question worth considering, as it can help investors understand the sort of expectations built into a given company's shares. One quick way to evaluate this is to generate a stock's expected rate of return -- what the market expects a stock to deliver given the risk the stock represents. Since only a few data points are used to calculate this figure, it's by no means a perfect measure, but it's certainly a good start, and can be a useful measure when considered as one of a number of different valuation tools.
The number is calculated as follows: Take the risk-free rate (the rate of return you can get on Treasury bonds), and add to it the number you get by multiplying the stock's beta (a common measure of volatility) by the equity risk premium (the difference between the expected return of the stock market and the risk-free rate). All of these numbers can be easily found online except for the market's expected return, which you can estimate yourself using historical figures or other data.
I put Krispy Kreme to this test using a range of variables for the risk-free rate and the market's expected return. The results won't be scientific anyway, so I'd rather generate a few different figures than rely on just one. Lower risk-free rates (for Treasury bills with a shorter term) and a more modest market return get us a number for Krispy Kreme of around 9%, while the 30-year bond and a market return of 11% get us about 17%.
These figures support the idea that investors should expect Krispy Kreme (a Motley Fool Stock Advisor holding) to beat the market over time. The next steps, however, are more difficult: You need to decide how much you're willing to pay for such returns, and how likely you believe those returns are. By calculating Krispy Kreme's expected rate of return, you're given one more tool with which to make an informed decision
What do you think? Do you believe the Krispy Kreme buzz or do you think this doughnut's a real hole for your money? Let us and other Fool's know on the Krispy Kreme discussion board.
Dave Marino-Nachison can be reached at firstname.lastname@example.org.
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