Valuing shares when government policies keep changing
Times for CFOs to rethink valuation fundamentals
CFOs and valuation professionals have long relied on models built around stable fundamentals. When uncertainty stems from those fundamentals, these models remain reliable. But in the first half of 2025, uncertainty was increasingly driven by policy shifts. Sudden changes in tariffs, spending, and investment, often without warning, reshaped investor expectations. Markets reacted to headlines, often before fundamentals adjusted. Even government bonds and currencies have behaved unpredictably.
When headlines move markets faster than earnings
In early 2025, markets responded more to policy signals than fundamentals. U.S. tariff announcements triggered a sharp equity selloff, well ahead of any earnings impact. When tariffs were postponed, markets rebounded, and by June, the S&P 500 reached a record high, highlighting how policy sentiment now drives valuations.
Globally, countries introduced countermeasures. Germany relaxed fiscal rules to fund massive defence spending, unsettling investors. Meanwhile, looser monetary policy and flexible inflation targets led investors to demand higher yields. Anticipating large EU bond issuance, investors sold sovereign bonds, raising yields and pushing prices down.
Defence spending may spur growth but also adds debt, borrowing costs, and increases sovereign downgrade risks. Coupled with inflation fears, this has amplified volatility and earnings uncertainty.
For CFOs, the lesson is clear: policy uncertainty now influences valuations, perhaps as much as fundamentals. Markets move faster than companies can adjust, rendering static valuation inputs less reliable.
Government bonds market moving against expectations
Traditionally seen as safe during equity sell-offs, government bonds were swept into early 2025’s market volatility. As equities declined, yields on U.S. Treasury STRIPS and German bonds rose, breaking their usual inverse correlation.
Both asset classes fell in tandem, weakening diversification. Between December 2024 and March 2025, the S&P Europe 350 rose 6.5%, while German long-term bond yields climbed 0.9 percentage points, raising discount rates and lowering DCF-based valuations.
This divergence highlights the limitations of relying on spot risk-free rates. Averaging yields can reduce short-term noise but must be applied consistently and backed by clear rationale.
Understanding the underlying drivers of rate increases is critical. In cyclical scenarios, rates rise with growth and inflation, but higher expected cash flows often offset the impact. A high risk-free rate relative to inflation typically signals real economic expansion.
In policy-driven scenarios, uncertainty, such as tariffs or rising public debt, pushes rates higher. Firms with pricing power may pass on costs but risk volume loss; others absorb costs, compressing their margins. Uncertainty can also delay investment, and rising defence budgets may divert public funding from other sectors, dampening their growth prospects.
While cyclical rate hikes are usually valuation-neutral or even positive, policy-driven hikes, like those in early 2025, are harder to interpret and demand greater judgment from CFOs.
Currency movements: A mixed blessing
In early 2025, the U.S. dollar saw its worst start to a year since 1973, driven by tariffs, unpredictable trade policy, and a projected $2.5–3.0 trillion debt increase. Investors turned to other currencies like the euro, which appreciated significantly.
For USD-based companies, effects are mixed. Exporters benefit from improved competitiveness and translation gains, while importers face higher costs and margin pressure. For euro-based firms, the reverse holds. Exporters to the U.S. lose price advantage, while importers gain from cheaper U.S. goods. Tariffs often offset or intensify the currency effects.
CFOs must cut through this complexity and assess how both exchange rate shifts and the policy forces behind them may influence business value.
Diverging models undermine certainty
Policy shifts have made it harder to reconcile outcomes from different valuation methods. For instance, a 0.9-point rise in the discount rate lowers DCF value (by approx. 10%). Yet, if valuation multiples follow the S&P Europe 350, value could rise by 6.5%.
This is counterintuitive and highlights the limits of relying solely on calculations. CFOs must recognize when inputs reflect sentiment, not fundamentals, and avoid overreliance on one valuation method. Judgment is essential.
Developed market country risk is becoming a reality
Country risk, typically associated with weak institutions or political instability, has long been priced into emerging markets through cash flow adjustments and risk premiums. Risk premiums for emerging markets are often derived from the yield spread between Eurodollar bonds issued by emerging countries and U.S. Treasuries. When yields on U.S. Treasuries rise, the spread narrows, ironically increasing valuations for emerging markets, despite no real change in fundamentals or risk.
Today, uncertainty is also affecting traditionally stable regions like the U.S. and EU. Yet most valuation models still lack a consistent way to capture sudden policy shifts and uncertainty in these developed markets.
CFOs must now re-evaluate country risk assumptions across the board. This is particularly complex because historical spreads may understate risk in emerging markets, and established methods to incorporate policy uncertainty in developed economies do not exist.
Limits of advanced financial modelling to capture policy uncertainty
Complex financial models don’t always yield more reliable results than simpler models. Policy uncertainty can make even advanced forecasts vulnerable to false precision.
For example, modelling a production shift from China to the U.S. may capture logistics but miss strategic implications, like giving up access to China’s manufacturing ecosystem.
CFOs must weigh qualitative insights and scenario planning as carefully as quantitative methods.
Terminal Value: One of the biggest risk variables
Terminal value relies on three key inputs: terminal-year cash flow, the discount rate, and the long-term growth rate, making it especially vulnerable to policy uncertainty.
Forecasting that far ahead is already challenging. Potential policy reversals add further uncertainty around what level of cash flows to assume. Tariffs and rising public debt may affect long-term inflation expectations, but such adjustments tend to be slow, if they happen at all.
Using average spot rates can help smooth discount rate volatility and bring more stability to long-term assumptions. While it may still be too early to revise these long-term assumptions, CFOs must recognise that terminal value remains a highly uncertain input. Balancing near-term volatility with the possibility of lasting policy change is a tough, but essential, judgment call.
Conclusion: Valuation is now a strategic CFO function
In today’s environment, the most credible valuations aren’t always those built on advanced financial models. In fact, complexity can obscure risk and give a false sense of precision.
CFOs must revisit valuation assumptions, apply informed judgment, and recognise when traditional benchmarks need to be reconsidered. Scenario analysis and clear reasoning around deviations from standard frameworks are now essential. Increasingly, regulators and auditors may view such departures as appropriate responses to abnormal conditions.
Ultimately, CFOs must look beyond model outputs—understanding the drivers behind interest rate movements, market reactions, sentiment shifts, and policy uncertainty. Today’s most reliable valuations are grounded in transparent assumptions, sound judgment, and narratives that stakeholders can clearly understand and trust.
Partner Valuation Advisory
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