Capital Asset Pricing Model CAPM

A model that estimates required return from one factor: how much a stock moves with the overall market.

Part of the Intrinsic Value & DCF course · Lesson 9 of 15

Formula

Expected return = Rf + Beta x (Rm - Rf)

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.

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