Doctor

Advanced Valuation
Aswath Damodaran
www.damodaran.com

Aswath Damodaran

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Some Initial Thoughts
" One hundred thousand lemmings cannot be wrong"










Graffiti

Aswath Damodaran

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Misconceptions about Valuation
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Myth 1: A valuation is an objective search for “true” value
•  Truth 1.1: All valuations are biased. The only questions are how muchand in which direction.
•  Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid.

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Myth 2.: A good valuation provides a precise estimate of value
•  Truth 2.1: There are no precise valuations
•  Truth 2.2: The payoff to valuation is greatest when valuation is least precise.

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Myth 3: . The morequantitative a model, the better the valuation
•  Truth 3.1: One’s understanding of a valuation model is inversely proportional to the number of inputs required for the model.
•  Truth 3.2: Simpler valuation models do much better than complex ones.

Aswath Damodaran

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Approaches to Valuation
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Discounted cashflow valuation, relates the value of an asset to the presentvalue of expected future cashflows on that asset.
Relative valuation, estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales.
Contingent claim valuation, uses option pricing models to measure the value of assets that share option characteristics.

Aswath Damodaran

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Discounted Cash FlowValuation
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What is it: In discounted cash flow valuation, the value of an asset is the present value of the expected cash flows on the asset.
Philosophical Basis: Every asset has an intrinsic value that can be estimated, based upon its characteristics in terms of cash flows, growth and risk.
Information Needed: To use discounted cash flow valuation, you need
•  to estimate thelife of the asset
•  to estimate the cash flows during the life of the asset
•  to estimate the discount rate to apply to these cash flows to get present value

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Market Inefficiency: Markets are assumed to make mistakes in pricing assets across time, and are assumed to correct themselves over time, as new information comes out about assets.

Aswath Damodaran

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DCF Choices: EquityValuation versus Firm Valuation
Firm Valuation: Value the entire business
Assets
Existing Investments Generate cashflows today Includes long lived (fixed) and short-lived(working capital) assets Expected Value that will be created by future investments Assets in Place Debt

Liabilities
Fixed Claim on cash flows Little or No role in management Fixed Maturity Tax Deductible

Growth AssetsEquity

Residual Claim on cash flows Significant Role in management Perpetual Lives

Equity valuation: Value just the equity claim in the business

Aswath Damodaran

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The Drivers of Value…

Growth from new investments Growth created by making new investments; function of amount and quality of investments Current Cashflows These are the cash flows from existing investment,s, net ofany reinvestment needed to sustain future growth. They can be computed before debt cashflows (to the firm) or after debt cashflows (to equity investors).

Efficiency Growth Growth generated by using existing assets better Terminal Value of firm (equity)

Expected Growth during high growth period

Stable growth firm, with no or very limited excess returns

Length of the high growth periodSince value creating growth requires excess returns, this is a function of - Magnitude of competitive advantages - Sustainability of competitive advantages

Cost of financing (debt or capital) to apply to discounting cashflows Determined by - Operating risk of the company - Default risk of the company - Mix of debt and equity used in financing

Aswath Damodaran

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DISCOUNTED CASHFLOW...