What is a common historical equity premium used in valuation?

The historical equity premium is the additional return that investors expect from holding stocks over risk-free investments, such as government bonds. A widely accepted figure for the historical equity premium is around 7%. This amount is derived from historical data showing the average outperformance of equities over the long term compared to safer assets.

Using 7% as the equity premium is common in financial analysis and valuation because it reflects a balance between the risk associated with equity investing and the historical returns that investors have actually experienced. This number tends to be utilized in Discounted Cash Flow (DCF) analyses to reflect the expected return rates required by equity investors when evaluating potential investments.

Different estimates for the equity premium exist, drawing from studies over various timeframes, but around 7% has become a standard figure thanks to its representation of long-term stock market performance. This choice offers a general guideline that aligns with historical trends and investor expectations in financial modeling and valuation scenarios.