emergmkts - Volatility Rules: Valuing Emerging Market...

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Volatility Rules: Valuing Emerging Market Companies September 2009 Aswath Damodaran Stern School of Business adamodar@stern.nyu.edu
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Volatility Rules: Valuing Emerging Market Companies As the center of gravity shifts from developed markets in the United States to emerging markets in Asia and Latin America, analysts are also grappling with estimation questions that arise more frequently with emerging market companies. In this paper, we begin by looking at common errors that show up in emerging market company valuations. We then deal with two big issues that underlie these valuations. The first relates to country risk and how best to deal with it in valuation. In particular, what are the country risks that we should incorporate into cash flows and when does country risk affect discount rates? The second arises from the lack of transparency and poor corporate governance that characterize many emerging market companies. We close the paper by examining how best to do relative valuation in emerging markets, especially when the comparable companies are listed in other markets.
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The center of gravity for the global economy is shifting from the United States and Western Europe to Asia and Latin America. Increasingly, we are being called upon to value emerging market companies, as they become larger players in the global economy as well as candidates for investment portfolios. In this paper, we will focus on issues, which while not unique to emerging market companies, take on a larger role with them. In particular, many of these companies operate in markets with unstable currencies and inflation, as well as significant and shifting country risk. If we add on financial statements that are not always informative and weak corporate governance, valuing emerging market companies can pose serious valuation issues. We will begin by looking at common errors made by analysts valuing emerging market companies – currency mismatches, double (or triple) counting country risk and a failure to systematically consider the effects of different classes of shares – and suggest ways in which we can avoid these mistakes. The bottom line, though, is that no matter how carefully we approach the valuation of these companies, our final estimates of value will be more volatile for these firms than for otherwise similar companies in developed markets. Role of Emerging Market Companies At the start of the 1990s, the United States, Western Europe and Japan still represented the bulk of the global economy, and Asian and Latin American countries may have had high growth potential, but accounted for only a small portion of world output. In the last two decades, emerging markets, especially India and China, have become much larger players in global economic growth. In this section, we will begin by looking at the growing clout of emerging market companies, then examine why the valuation of these companies has become more critical to investors and analysts and close by listing factors that characterize these companies. Emerging market companies in the Global Economy
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emergmkts - Volatility Rules: Valuing Emerging Market...

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