What is Cost of Equity?
The cost of equity is the return shareholders require for investing in a company’s stock. It compensates investors for the risk of equity ownership and is a key input in valuation.
How It Works
- Estimate using CAPM: risk-free rate + beta × equity risk premium.
- Or use dividend discount model: (next dividend / share price) + growth rate.
- Use as the discount rate for equity cash flows.
Saudi Context
Saudi equity analysts often build CAPM using a SAR-based risk-free rate (Saudi government bond yield), a country-adjusted equity risk premium, and sector betas from Tadawul.
Example
A Saudi company has a beta of 1.1, a risk-free rate of 4.5%, and an equity risk premium of 6%. Cost of equity is 4.5% + 1.1 × 6% = 11.1%.