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mar16 stupid mac - Chapter 1: Introduction to Valuation...

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Chapter 1: Introduction to Valuation Philosophical Basis for Valuation Bigger Fool Theory: Valuation is not necessary as long as there is a “bigger fool” willing to buy the asset from you -Very dangerous game to play because there is no guarantee that there will be someone to buy the asset from you -Absurd to think that value is in the eye of the beholder and any price is justified as long as there are buyers willing to pay that price Price should be paid on an asset based on reality and expected cashflows! Areas of Disagreement Areas of Agreement -How to estimate true value -How long it will take prices to adjust to true value -Asset prices cannot be justified merely by the argument that there will be other investors around willing to pay a higher price in the future Generalities about Valuation Myth 1: Since valuation models are quantitative, valuation is objective! Valuation may be quantitative but the inputs require subjective judgment! -Thus, final value is colored by bias we bring into process -Given external exposure to information, analysis, and opinions, bias cannot be completely eliminated In order to reduce the bias: 1) Avoid strong public positions on value of firm before valuation is complete 2) Minimize your stake in whether the firm is over- or under-valued When looking at valuation done by third parties, the biases of the analysts should be considered! Institutional concerns also affect how much bias goes into valuation -Ex: Equity research analysts are more likely to make buy than sell recommendations, because: -Analysts have limited access to information on firms they have issued sell recommendations on -Portfolio managers pressure analysts for glowing reports of firms when they hold large positions in those companies -Investment bankers also pressure analysts for glowing reports -Ex: Target firm in a takeover may give a high self-valuation
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Myth 2: A well-researched and well-done valuation is timeless Value of firm obtained from valuation model is affected by firm-specific and marketwide information -New information is constantly revealed in financial markets Thus, valuations age quickly as time passes and should be updated to reflect current information! Firm-specific Information Sector-specific Information Marketwide Information Ex: Earnings report revealing firm’s performance in most recent time period and business model of firm Ex: Pharmaceutical companies highly valued because of high growth prospects would be valued less highly in the future because of dimmed growth prospects Ex: State of economy and level of interest rates Myth 3: A good valuation provides a precise estimate of value Absolute certainty in valuation is impossible because assumptions have to be made about future of company and economy, and because future cashflows and discount rates have to be estimated -Analysts must have a margin of error Degree of precision in valuation can vary across investments: -Large, mature firms with long financial history will have a more precise valuation than a small, young
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This note was uploaded on 08/13/2011 for the course NBA 6560 taught by Professor David during the Spring '08 term at Cornell.

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mar16 stupid mac - Chapter 1: Introduction to Valuation...

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