How to Calculate the Expected Return of a Stock Using the CAPM (Capitalized Asset Pricing Model)

CAPM graph

What is the capitalized pricing asset model?

The capitalized pricing asset model allows you to estimate your return when investing in a stock based on the level of risk that you are taking. The model assumes that a stock's price is the sum of two components: the risk-free rate, and a premium for a company-specific risk factor. This factor is typically referred to as beta or systematic risk, and it reflects how much a stock deviates from the market. If you invest in more risky stocks with higher betas, you should expect a higher stock return for that particular company.

CAPM Formula

The formula of the capitalized pricing model looks like this:

Breaking it down, here’s what you need to know for any given stock:

  1. Risk-free rate: you can easily the stock’s risk-free rate on Google by searching, “10-year treasury note for …” and using that rate.
  2. Expected market return: you can also Google this value, although the historical average market return has been around 7–8%
  3. Stock beta: You can calculate the stock beta manually using the formula below, or use the beta found on websites like Bloomberg and Yahoo Finance.

Once you have found all of the above values, you can calculate the stock’s estimated return using the CAPM formula.

Let’s do Apple as an example:

  • The risk-free rate as of today (July 24, 2021) is 1.276%
  • The expected return is 7.5%
  • According to Yahoo Finance, the beta is 1.21

Altogether we find:

Apple’s expected return = 0.01276 + 1.21*(0.075–0.01276)

=0.08807 or 8.80704%

Apple’s expected return is 8.80704%. This means that if Apple did not have any specific risk factors, you could expect to make 8.80704% on your money over the course of one year

Now you know how to calculate a company’s expected return using the CAPM method.

Keep in mind this method is not perfect and has its pros and cons that you should consider. However, it is very useful to think about the relationship between the risk you are taking versus the return you should expect.

If you want to learn more about how you can get stock financials, key metrics, and growth metrics right on Excel or Google Sheets in seconds, check out www.wisesheets.io

To your investing success,

The Wisesheets Team

Hello! I'm a finance enthusiast who fell in love with the world of finance at 15, devouring Warren Buffet's books and streaming Berkshire Hathaway meetings like a true fan.

I started my career in the industry at one of Canada's largest REITs, where I honed my skills analyzing and facilitating over a billion dollars in commercial real estate deals.

My passion led me to the stock market, but I quickly found myself spending more time gathering data than analyzing companies.

That's when my team and I created Wisesheets, a tool designed to automate the stock data gathering process, with the ultimate goal of helping anyone quickly find good investment opportunities.

Today, I juggle improving Wisesheets and tending to my stock portfolio, which I like to think of as a garden of assets and dividends. My journey from a finance-loving teenager to a tech entrepreneur has been a thrilling ride, full of surprises and lessons.

I'm excited for what's next and look forward to sharing my passion for finance and investing with others!

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