ValIntro - An Introduction to Valuation! Spring 2012 Aswath...

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Aswath Damodaran 1 An Introduction to Valuation Spring 2012 Aswath Damodaran
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Aswath Damodaran 2 Some Initial Thoughts " One hundred thousand lemmings cannot be wrong" GrafFti We thought we were in the top of the eighth inning, when we were in the bottom of the ninth. . Stanley Druckenmiller
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Aswath Damodaran 3 A philosophical basis for Valuation “Valuation is often not a helpful tool in determining when to sell hyper- growth stocks” , Henry Blodget, Merrill Lynch Equity Research Analyst in January 2000, in a report on Internet Capital Group, which was trading at $174 then. There have always been investors in fnancial 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±ows or earnings. Perceptions matter , but they cannot be all the matter. IF perceptions are at war with reality, reality always wins out (in the end). Asset prices cannot be justifed by merely using the bigger Fool theory. Postscript : Internet Capital Group was trading at $ 3 in January 2001.
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Aswath Damodaran 4 Misconceptions about Valuation Myth 1: A valuation is an objective search for true value Truth 1.1: All valuations are biased. The only questions are “how much” and 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. 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. Myth 3: . The more quantitative 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.
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Aswath Damodaran 5 Approaches to Valuation Intrinsic valuation , relates the value of an asset to its intrinsic characteristics: its capacity to generate cash Fows and the risk in the cash Fows. In it’s most common form, intrinsic value is computed with a discounted cash Fow valuation, with the value of an asset being the present value of expected future cashFows 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, cashFows, book value or sales. Contingent claim valuation , uses option pricing models to measure the value of assets that share option characteristics.
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Aswath Damodaran 6 Basis for all valuation approaches The use of valuation models in investment decisions (i.e., in decisions on which assets are under valued and which are over valued) are based upon a perception that markets are inefFcient and make mistakes in assessing value an assumption about how and when these inefFciencies will get corrected
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ValIntro - An Introduction to Valuation! Spring 2012 Aswath...

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