CAPM builds the cost of equity from the risk-free rate plus a risk premium.
What it is
CAPM is the standard way to estimate a stock's cost of equity. It says the return investors require equals the risk-free rate plus a premium for the stock's exposure to market risk, measured by beta. Only market-wide (systematic) risk is rewarded; company-specific risk is assumed to be diversifiable.
Why it matters
CAPM is the most widely used input for the discount rate in valuation, so understanding it helps you judge whether a model's assumptions are reasonable. Its simplicity is also its weakness — it relies on a single beta and a chosen risk premium, both of which are estimates that can be debated.
How it's calculated
Take the risk-free rate, then add beta multiplied by the equity risk premium (the expected market return minus the risk-free rate). Beta of 1.0 implies the stock is expected to move with the market; above 1.0 implies more volatility.
How Quintarthai uses it
A company's beta is listed on its deep-analysis Statistics tab, so you can plug it into CAPM with your own risk-free rate and premium assumptions.
Cross-border note. Beta depends on the index used as the market benchmark — a Canadian stock's beta against the S&P/TSX Composite can differ from its beta against the S&P 500. Confirm which market index the beta is measured against before using it cross-border.
FAQ
What is beta?
Beta measures how much a stock tends to move relative to the broad market. A beta of 1.5 means the stock has historically moved about 1.5 times as much as the market, in either direction; a beta below 1.0 means it moves less.
What is the equity risk premium?
It is the extra return investors expect from stocks over a risk-free asset like government bonds. It is an assumption, commonly set somewhere around 4-6%, and reasonable analysts disagree on the right figure.
Check your understanding
According to CAPM, which type of risk is rewarded with a higher required return?
CAPM assumes company-specific risk is diversifiable and unrewarded, so only market-wide (systematic) risk, captured by beta, earns a premium.