valuesurvey

valuesurvey - 1 Valuation Approaches and Metrics: A Survey...

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Unformatted text preview: 1 Valuation Approaches and Metrics: A Survey of the Theory and Evidence Aswath Damodaran Stern School of Business November 2006 2 Valuation Approaches and Metrics: A Survey Article Valuation lies at the heart of much of what we do in finance, whether it is the study of market efficiency and questions about corporate governance or the comparison of different investment decision rules in capital budgeting. In this paper, we consider the theory and evidence on valuation approaches. We begin by surveying the literature on discounted cash flow valuation models, ranging from the first mentions of the dividend discount model to value stocks to the use of excess return models in more recent years. In the second part of the paper, we examine relative valuation models and, in particular, the use of multiples and comparables in valuation and evaluate whether relative valuation models yield more or less precise estimates of value than discounted cash flow models. In the final part of the paper, we set the stage for further research in valuation by noting the estimation challenges we face as companies globalize and become exposed to risk in multiple countries. 3 Valuation can be considered the heart of finance. In corporate finance, we consider how best to increase firm value by changing its investment, financing and dividend decisions. In portfolio management, we expend resources trying to find firms that trade at less than their true value and then hope to generate profits as prices converge on value. In studying whether markets are efficient, we analyze whether market prices deviate from value, and if so, how quickly they revert back. Understanding what determines the value of a firm and how to estimate that value seems to be a prerequisite for making sensible decisions. Given the centrality of its role, you would think that the question of how best to value a business, private or public, would have been well researched. As we will show in this paper, the research into valuation models and metrics in finance is surprisingly spotty, with some aspects of valuation, such as risk assessment, being deeply analyzed and others, such as how best to estimate cash flows and reconciling different versions of models, not receiving the attention that they deserve. Overview of Valuation Analysts use a wide spectrum of models, ranging from the simple to the sophisticated. These models often make very different assumptions about the fundamentals that determine value, but they do share some common characteristics and can be classified in broader terms. There are several advantages to such a classification -- it makes it is easier to understand where individual models fit in to the big picture, why they provide different results and when they have fundamental errors in logic....
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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valuesurvey - 1 Valuation Approaches and Metrics: A Survey...

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