Damodaran on Valuation E-Book

Aswath Damodaran

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Finance Editions
• Sprache: Englisch

Seitenzahl: 1363

Veröffentlichungsjahr: 2011

Beschreibung

"Aswath Damodaran is simply the best valuation teacher around. If you are interested in the theory or practice of valuation, you should have Damodaran on Valuation on your bookshelf. You can bet that I do." -- Michael J. Mauboussin, Chief Investment Strategist, Legg Mason Capital Management and author of More Than You Know: Finding Financial Wisdom in Unconventional Places In order to be a successful CEO, corporate strategist, or analyst, understanding the valuation process is a necessity. The second edition of Damodaran on Valuation stands out as the most reliable book for answering many of today?s critical valuation questions. Completely revised and updated, this edition is the ideal book on valuation for CEOs and corporate strategists. You'll gain an understanding of the vitality of today?s valuation models and develop the acumen needed for the most complex and subtle valuation scenarios you will face.

Leseprobe

Contents

Preface

Chapter 1: Introduction to Valuation

A Philosophical Basis for Valuation

Inside the Valuation Process

Approaches to Valuation

Role of Valuation

Conclusion

Part One: Discounted Cash Flow Valuation

Chapter 2: Estimating Discount Rates

What is Risk?

Cost of Equity

From Cost of Equity to Cost of Capital

Conclusion

Chapter 3: Measuring Cash Flows

Categorizing Cash Flows

Earnings

Tax Effect

Reinvestment Needs

From Firm to Equity Cash Flows

Conclusion

Chapter 4: Forecasting Cash Flows

Structure of Discounted Cash Flow Valuation

Length of Extraordinary Growth Period

Detailed Cash Flow Forecasts

Terminal Value

Estimation Approaches

Conclusion

Chapter 5: Equity Discounted Cash Flow Models

Dividend Discount Models

FCFE (Potential Dividend) Discount Models

FCFE Versus Dividend Discount Model Valuation

Per Share Versus Aggregate Valuation

Conclusion

Chapter 6: Firm Valuation Models

Cost of Capital Approach

Adjusted Present Value Approach

Excess Return Models

Capital Structure and Firm Value

Conclusion

Part Two: Relative Valuation

Chapter 7: Relative Valuation: First Principles

What is Relative Valuation?

Ubiquity of Relative Valuation

Reasons for Popularity and Potential Pitfalls

Standardized Values and Multiples

Four Basic Steps to Using Multiples

Reconciling Relative and Discounted Cash Flow Valuations

Conclusion

Chapter 8: Equity Multiples

Definitions of Equity Multiples

Distributional Characteristics of Equity Multiples

Analysis of Equity Multiples

Applications of Equity Multiples

Conclusion

Chapter 9: Value Multiples

Definition of Value Multiples

Distributional Characteristics of Value Multiples

Analysis of Value Multiples

Applications of Value Multiples

Conclusion

Part Three: Loose Ends in Valuation

Chapter 10: Cash, Cross Holdings, and Other Assets

Cash and Near-Cash Investments

Financial Investments

Holdings in Other Firms

Other Nonoperating Assets

Conclusion

Appendix 10.1: Industry Averages: Cash Ratios—January 2005

Chapter 11: Employee Equity Options and Compensation

Equity-Based Compensation

Employee Options

Restricted Stock

Conclusion

Chapter 12: The Value of Intangibles

Importance of Intangible Assets

Independent and Cash-Flow-Generating Intangible Assets

Firmwide Cash-Flow-Generating Intangible Assets

Intangible Assets with Potential Future Cash Flows

Conclusion

Appendix 12.1: Option Pricing Models

Chapter 13: The Value of Control

Measuring the Expected Value of Control

Manifestations of the Value of Control

Conclusion

Chapter 14: The Value of Liquidity

Measuring Illiquidity

Cost of Illiquidity: Theory

Cost of Illiquidity: Empirical Evidence

Dealing with Illiquidity in Valuation

Consequences of Illiquidity

Conclusion

Chapter 15: The Value of Synergy

What is Synergy?

Valuing Synergy

Dubious Synergies

Evidence on Synergy—Value Created and Added

Common Errors in Valuing Synergy

Conclusion

Chapter 16: The Value of Transparency

An Experiment

Defining Complexity

Sources of Complexity

Reasons for Complexity

Measuring Complexity

Consequences of Complexity

Dealing with Complexity

Cures for Complexity

Conclusion

Appendix 16.1: Standard & Poor’s Transparency and Disclosure Index: Key Questions

Appendix 16.2: Measuring Complexity with a Score—An Example

Chapter 17: The Cost of Distress

Possibility and Consequences of Financial Distress

Discounted Cash Flow Valuation

Relative Valuation

From Firm to Equity Value in Distressed Firms

Conclusion

Chapter 18: Closing Thoughts

Choices in Valuation Models

Which Approach Should We Use?

Choosing the Right Discounted Cash Flow Model

Choosing the Right Relative Valuation Model

When should We Use the Option Pricing Models?

Ten Steps to Better Valuations

Conclusion

Index

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Copyright © 2006 by Aswath Damodaran. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Damodaran, Aswath.

Damodaran on valuation : security analysis for investment and corporate finance / Aswath Damodaran.—2nd ed.

p. cm.—(Wiley finance series) Includes index.

ISBN-13 978-0-471-75121-2 (cloth) ISBN-10 0-471-75121-9 (cloth)

1. Corporations—Valuation—Mathematical models. 2. Capital assets pricing model. 3. Investment analysis. I. Title. II. Series.

HG4028.V3D35 2006 658.15—dc22

2006004905

To all those people with whom

I have debated valuation issues over time

and who have pointed out the errors

(or at least the limitations)

of my ways

Preface

There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world.

—John Maynard Keynes

Lord Keynes was not alone in believing that the pursuit of true value based on financial fundamentals is a fruitless one in markets where prices often seem to have little to do with value. There have always been investors in financial markets who have argued that market prices are determined by the perceptions (and misperceptions) of buyers and sellers, and not by anything as prosaic as cash flows or earnings. I do not disagree with them that investor perceptions matter, but I do disagree with the notion that they are all that matter. It is a fundamental precept of this book that it is possible to estimate value from financial fundamentals, albeit with error, for most assets, and that the market price cannot deviate from this value in the long term.1 From the tulip bulb craze in Holland in the early seventeenth century to the South Sea Bubble in England in the 1800s to the stock markets of the present, markets have shown the capacity to correct themselves, often at the expense of those who believed that the day of reckoning would never come.

The first edition of this book was my first attempt at writing a book, and hopefully I have gained from my experiences since. In fact, this edition is very different from the prior edition for a simple reason. My other book on investment valuation, also published by John Wiley & Sons, was designed to be a comprehensive valuation book, and repeating what was said in that book here, in compressed form, strikes me as a waste of time and resources.

This book has three parts to it. The first two parts, which stretch through the first nine chapters, provide a compressed version of both discounted cash flow and relative valuation models and should be familiar territory for anyone who has done or read about valuation before. The third part, which comprises the last nine chapters, is dedicated to looking at what I call the loose ends in valuation that get short shrift in both valuation books and discussions. Included here are topics like liquidity, control, synergy, transparency, and distress, all of which affect valuations significantly but either are dealt with in a piecemeal fashion or take the form of arbitrary premiums and discounts. You will notice that this section has more references to prior work in the area and is denser, partly because there is more debate about what the evidence is and what we should do in valuation. I do not claim to have the answer to what the value of control should be in a firm, but the chapter on control should give you a road map that may help you come up with the answer on your own.

The four basic principles that I laid out in the Preface to the first edition continue to hold on this one. First, I have attempted to be as comprehensive as possible in covering the range of valuation models that are available to an analyst doing a valuation, while presenting the common elements in these models and providing a framework that can be used to pick the right model for any valuation scenario. Second, the models are presented with real-world examples, warts and all, so as to capture some of the problems inherent in applying these models. There is the obvious danger that some of these valuations will appear to be hopelessly wrong in hindsight, but this cost is well worth the benefits. Third, in keeping with my belief that valuation models are universal and not market-specific, illustrations from markets outside the United States are interspersed through the book. Finally, I have tried to make the book as modular as possible, enabling a reader to pick and choose sections of the book to read, without a significant loss of continuity.

Aswath Damodaran

New York, New York

June 2006

1But then again, as Keynes would have said, “In the long term, we are all dead.”

CHAPTER 1

Introduction to Valuation

Knowing what an asset is worth and what determines that value is a prerequisite for intelligent decision making—in choosing investments for a portfolio, in deciding on the appropriate price to pay or receive in a takeover, and in making investment, financing, and dividend choices when running a business. The premise of this book is that we can make reasonable estimates of value for most assets, and that the same fundamental principles determine the values of all types of assets, real as well as financial. Some assets are easier to value than others, the details of valuation vary from asset to asset, and the uncertainty associated with value estimates is different for different assets, but the core principles remain the same. This chapter lays out some general insights about the valuation process and outlines the role that valuation plays in portfolio management, in acquisition analysis, and in corporate finance. It also examines the three basic approaches that can be used to value an asset.

A PHILOSOPHICAL BASIS FOR VALUATION

A postulate of sound investing is that an investor does not pay more for an asset than it is worth. This statement may seem logical and obvious, but it is forgotten and rediscovered at some time in every generation and in every market. There are those who are disingenuous enough to argue that value is in the eyes of the beholder, and that any price can be justified if there are other investors willing to pay that price. That is patently absurd. Perceptions may be all that matter when the asset is a painting or a sculpture, but we do not and should not buy most assets for aesthetic or emotional reasons; we buy financial assets for the cash flows we expect to receive from them. Consequently, perceptions of value have to be backed up by reality, which implies that the price we pay for any asset should reflect the cash flows it is expected to generate. The models of valuation described in this book attempt to relate value to the level of, uncertainty about, and expected growth in these cash flows.

There are many aspects of valuation where we can agree to disagree, including estimates of true value and how long it will take for prices to adjust to that true value. But there is one point on which there can be no disagreement. Asset prices cannot be justified by merely using the argument that there will be other investors around who will pay a higher price in the future. That is the equivalent of playing a very expensive game of musical chairs, where every investor has to answer the question “Where will I be when the music stops?” before playing. The problem with investing with the expectation that when the time comes there will be a bigger fool around to whom to sell an asset is that you might end up being the biggest fool of all.

INSIDE THE VALUATION PROCESS

There are two extreme views of the valuation process. At one end are those who believe that valuation, done right, is a hard science, where there is little room for analyst views or human error. At the other are those who feel that valuation is more of an art, where savvy analysts can manipulate the numbers to generate whatever result they want. The truth does lies somewhere in the middle, and we use this section to consider three components of the valuation process that do not get the attention they deserve—the bias that analysts bring to the process, the uncertainty that they have to grapple with, and the complexity that modern technology and easy access to information have introduced into valuation.

Value First, Valuation to Follow: Bias in Valuation

We almost never start valuing a company with a blank slate. All too often, our views on a company are formed before we start inputting the numbers into the models that we use, and, not surprisingly, our conclusions tend to reflect our biases. We begin by considering the sources of bias in valuation and then move on to evaluate how bias manifests itself in most valuations. We close with a discussion of how best to minimize or at least deal with bias in valuations.

Sources of Bias

The bias in valuation starts with the companies we choose to value. These choices are almost never random, and how we make them can start laying the foundation for bias. It may be that we have read something in the press (good or bad) about the company or heard from an expert that it was undervalued or overvalued. Thus, we already begin with a perception about the company that we are about to value. We add to the bias when we collect the information we need to value the firm. The annual report and other financial statements include not only the accounting numbers but also management discussions of performance, often putting the best possible spin on the numbers. With many larger companies, it is easy to access what other analysts following the stock think about these companies. Zacks, IBES, and First Call, to name three services among many, provide summaries of how many analysts are bullish or bearish about the stock, and we can often access their complete valuations. Finally, we have the market’s own estimate of the value of the company—the market price—adding to the mix. Valuations that stray too far from this number make analysts uncomfortable, since they may reflect large valuation errors (rather than market mistakes).

In many valuations, there are institutional factors that add to this already substantial bias. For instance, equity research analysts are more likely to issue buy rather than sell recommendations; that is, they are more likely to find firms to be undervalued than overvalued.1 This can be traced partly to the difficulties analysts face in obtaining access to and collecting information on firms on which they have issued sell recommendations, and partly to pressure that they face from portfolio managers, some of whom might have large positions in the stock, and from their own firm’s investment banking arms, which have other profitable relationships with the firms in question.

The reward and punishment structure associated with finding companies to be undervalued and overvalued is also a contributor to bias. Analysts whose compensation is dependent upon whether they find firms to be under- or overvalued will be biased in their conclusions. This should explain why acquisition valuations are so often biased upward. The analysis of the deal, which is usually done by the acquiring firm’s investment banker, who also happens to be responsible for carrying the deal to its successful conclusion, can come to one of two conclusions. One is to find that the deal is seriously overpriced and recommend rejection, in which case the analyst receives the eternal gratitude of the stockholders of the acquiring firm but little else. The other is to find that the deal makes sense (no matter what the price is) and to reap the ample financial windfall from getting the deal done.