chap 1 - An Introduction to Valuation Fall 2001 Aswath...

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Aswath Damodaran 1 An Introduction to Valuation Fall 2001 Aswath Damodaran
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Aswath Damodaran 2 Some Initial Thoughts " One hundred thousand lemmings cannot be wrong" Graffiti We thought we were in the top of the eighth inning, when we 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 hypergrowth stocks ”, Henry Blodget, Merrill Lynch Equity Research Analyst in January 2000, in a report on Internet Capital Group, which was trading at $174 then. n There have always been investors in financial 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 cashflows or earnings. n Perceptions matter , but they cannot be all the matter. n Asset prices cannot be justified 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 n 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. n 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. n 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 n Discounted cashflow valuation , relates the value of an asset to the present value of expected future cashflows on that asset. n Relative valuation , estimates the value of an asset by looking at the pricing of 'comparable' assets relative to a common variable like earnings, cashflows, book value or sales. n Contingent claim valuation , uses option pricing models to measure the value of assets that share option characteristics.
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6 Basis for all valuation approaches n 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 inefficient and make mistakes in assessing value an assumption about how and when these inefficiencies will get corrected n In an efficient market, the market price is the best estimate of value . The purpose of any valuation model is then the justification of this
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chap 1 - An Introduction to Valuation Fall 2001 Aswath...

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