Infrastructure funds have begun acquiring companies with enduring assets at earnings multiples that stagger traditional investors. The premiums paid imply below-market rates of return. Even Warren Buffett, who avoided the tech frenzy, has placed a sizable bet on the rail industry. Is this a bubble or a long-term shift in the perceived value of enduring assets? If the latter, what has caused the change? And what are the long-term implications? The answers lie in the market perception of ownership risk on enduring assets.
When Bill Sharpe unveiled the Capital Asset Pricing Model in 1964, he introduced a key concept: The market-required return on a project depends not on its overall risk, but on its market risk or beta.
Under this model, many companies with enduring assets, such as ports or railroads, have high betas and therefore warrant a large market-risk premium and a correspondingly deep discount rate on future earnings. Betas are typically calculated by examining how the stock price varies relative to the market on a week-to-week basis. This calculation makes sense when stock prices are set by traders with rapid portfolio turnover, short investment horizons, and quarterly return criteria.
In contrast, the risk calculation changes when very-long-term investors, such as pension funds, consider a 30-year investment horizon. The beta for an infrastructure asset is lower and the appropriate risk premium smaller. A weekly fluctuation in stock price has little value in forecasting the long-run market risk. Measuring market risk within a business cycle becomes less important than measuring market risk across business cycles. And by that measure, these assets do very well.
Enduring assets, with their smaller discount for lower long-term market risk, are and always have been worth …