Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

Response From the Author

Fortnightly Magazine - April 1 2003

EMH.

Finally, regarding the third criticism, Mr. Hill thinks the entire volatility issue is a "straw man" I created, and that the DCF method has worked well for 30 years, producing "the most accurate" cost of equity estimates. My point is this: Increasingly, volatile utility stock prices can lead to widely varying COE estimates using the DCF, even when stock prices are averaged (in violation of the EMH). COE swings of 100 to 200 basis points can have a significant financial impact on utilities and their customers. Of all the common methods used to estimate a utility's COE, the DCF has the greatest volatility. Since Mr. Hill asserts that the DCF produces COE estimates closer to the "true" cost than any other method, one wonders how a utility's long-term COE can change so much so quickly, if its underlying financial fundamentals have changed little. Nor does Mr. Hill explain how he, or anyone else, can "know" the "true" COE, which cannot be observed directly. Nor does he explain why it provides greater certainty to this unknown truth than other market methods, which are also based on the EMH.

Ultimately, it is Mr. Hill whose advocacy is clear, but whose judgment is cloudy. I myself continue to use the DCF, in part because regulators require it. I am concerned about heavy reliance on the DCF, given what I see as fundamental changes in utility markets. Perhaps these markets will settle down and utilities will once again be the "widows and orphans" stocks they once were, but I doubt it. Until then, "DCF forever!" may be a nice sound bite for Mr. Hill, but it could sell his own clients short in the long run.

Articles found on this page are available to Internet subscribers only. For more information about obtaining a username and password, please call our Customer Service Department at 1-800-368-5001.

Pages