wk 1 - Role and Approaches to Valuation

wk 1 - Role and Approaches to Valuation - FINS3641 SECURITY...

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Prepared by Henry Yip 1 FINS3641 SECURITY ANALYSIS AND VALUATION PART 1 INTRODUCTION TO SECURITY VALUATION Week 1: The Role and Approaches to Valuation Topics: The role of valuation in portfolio management Discount Cash Flow (DCF) Valuation – definition, applicability and limitation Relative Valuation – definition, applicability and limitation Contingency Claim Valuation – definition, applicability and limitation Learning Outcomes: Recognise Valuations are estimates with errors that can’t be avoided Alternative models to match the pricing of different assets The linkage between valuation and the EMH Reading: Damodaran Chapters 1-2
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FINS3641 SAV Week 1: The Role and Approaches to Valuation 2 The Premise of and Facts about Valuation of Assets 1. The value of an asset is based on the level and expected growth of its cash flows in the future. 2. Valuation is Subjective and not precise. (Analysts may disagree on the fair value of a firm and need a reasonable margin for error. Inputs are just estimates!) Dynamic and ages quickly. (New information keeps arriving!) As good as the inputs. (More inputs don’t mean better valuation!) Keeps the market honest. (A price-value gap could encourage trading to drive price of a firm towards its fair value.) More than just the outcome on the value of a firm. There is a lot more to learn from the process, namely the relationship between the input variables and the value of a firm.
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FINS3641 SAV Week 1: The Role and Approaches to Valuation 3 The Role of Valuation of Financial Assets in Portfolio Management 1. Fundamental Analysts Relate the value of a financial asset to its financial characteristics Overweight (Underweight) in stocks that are under- (over-) valued Valuation is their bread and butter 2. Franchise Buyers (Private Equity) Focus on the valuation of simple and stable businesses that are well understood Buy up businesses that are undervalued and with the intention to add further value via better management and business restructuring Valuation is their bread and butter 3. Chartists Focus on investor psychology to determine (predictable) price movements rather valuation Valuation plays no role in their trading strategies Use valuation peripherally to explain resistance and support levels
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wk 1 - Role and Approaches to Valuation - FINS3641 SECURITY...

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