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Damodaran

on
Valuation

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. Inc. Damodaran on Valuation Security Analysis for Investment and Corporate Finance Second Edition ASWATH DAMODARAN John Wiley & Sons.

The advice and strategies contained herein may not be suitable for your situation. or other damages.. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages. consequential. Danvers. scanning. All rights reserved. 111 River Street.wiley. including but not limited to special. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book.V3D35 2006 658. Capital assets pricing model. John Wiley & Sons. photocopying. Hoboken. 2. incidental. Aswath. Inc. Series. HG4028. Inc.—(Wiley finance series) Includes index. stored in a retrieval system. Hoboken. cm. ISBN-13 978-0-471-75121-2 (cloth) ISBN-10 0-471-75121-9 (cloth) 1. (201) 748-6011. fax (978) 646-8600. or on the web at www. (978) 750-8400. I.com. You should consult with a professional where appropriate.wiley. recording.—2nd ed. they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. II. No part of this publication may be reproduced.. Published simultaneously in Canada.Copyright © 2006 by Aswath Damodaran. outside the United States at (317) 572-3993 or fax (317) 572-4002. Wiley also publishes its books in a variety of electronic formats. or transmitted in any form or by any means. except as permitted under Section 107 or 108 of the 1976 United States Copyright Act. Corporations—Valuation—Mathematical models. 3. Damodaran on valuation : security analysis for investment and corporate finance / Aswath Damodaran. visit our web site at www. fax (201) 748-6008.copyright. Inc. MA 01923. No warranty may be created or extended by sales representatives or written sales materials. Requests to the Publisher for permission should be addressed to the Permissions Department. 10 9 8 7 6 5 4 3 2 1 . Some content that appears in print may not be available in electronic books. For general information on our other products and services or for technical support. 222 Rosewood Drive. mechanical. p. Investment analysis. New Jersey. Published by John Wiley & Sons. Title.. Library of Congress Cataloging-in-Publication Data: Damodaran. or otherwise. or online at http://www. please contact our Customer Care Department within the United States at (800) 762-2974. without either the prior written permission of the Publisher. For more information about Wiley products. NJ 07030.com.15—dc22 2006004905 Printed in the United States of America. or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center. electronic.com/go/permissions.

To all those people with whom I have debated valuation issues over time and who have pointed out the errors (or at least the limitations) of my ways .

Contents Preface ix CHAPTER 1 Introduction to Valuation 1 PART ONE Discounted Cash Flow Valuation 25 CHAPTER 2 Estimating Discount Rates 27 CHAPTER 3 Measuring Cash Flows 79 CHAPTER 4 Forecasting Cash Flows 117 CHAPTER 5 Equity Discounted Cash Flow Models 157 CHAPTER 6 Firm Valuation Models 193 PART TWO Relative Valuation 231 CHAPTER 7 Relative Valuation: First Principles 233 CHAPTER 8 Equity Multiples 255 CHAPTER 9 Value Multiples 295 vii .

viii CONTENTS PART THREE Loose Ends in Valuation 325 CHAPTER 10 Cash. Cross Holdings. and Other Assets 327 CHAPTER 11 Employee Equity Options and Compensation 369 CHAPTER 12 The Value of Intangibles 407 CHAPTER 13 The Value of Control 457 CHAPTER 14 The Value of Liquidity 497 CHAPTER 15 The Value of Synergy 541 CHAPTER 16 The Value of Transparency 575 CHAPTER 17 The Cost of Distress 611 CHAPTER 18 Closing Thoughts 649 Index 665 .

Preface There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world.” ix . My other book on investment valuation. in compressed form. synergy. I do not claim to 1 But then again. but I do disagree with the notion that they are all that matter. The first edition of this book was my first attempt at writing a book. You will notice that this section has more refer- ences to prior work in the area and is denser. partly because there is more debate about what the evidence is and what we should do in valuation. “In the long term. Included here are topics like liquidity. is dedicated to looking at what I call the loose ends in valuation that get short shrift in both valuation books and discussions. —John Maynard Keynes ord Keynes was not alone in believing that the pursuit of true value based on fi- L nancial fundamentals is a fruitless one in markets where prices often seem to have little to do with value. which stretch through the first nine chapters. control. albeit with error. all of which affect valuations significantly but either are dealt with in a piecemeal fashion or take the form of ar- bitrary premiums and discounts. often at the expense of those who believed that the day of reckoning would never come. The first two parts. The third part. I do not disagree with them that investor perceptions matter. mar- kets have shown the capacity to correct themselves. strikes me as a waste of time and resources. and that the market price cannot deviate from this value in the long term. and not by anything as prosaic as cash flows or earn- ings. There have always been investors in financial markets who have argued that market prices are determined by the perceptions (and mispercep- tions) of buyers and sellers. and distress. It is a fundamental precept of this book that it is possible to estimate value from financial fundamentals. which comprises the last nine chapters. this edition is very different from the prior edition for a simple reason. was designed to be a comprehensive valua- tion book. also published by John Wiley & Sons. transparency. for most assets. and repeating what was said in that book here.1 From the tulip bulb craze in Holland in the early seventeenth century to the South Sea Bubble in England in the 1800s to the stock markets of the present. provide a compressed version of both discounted cash flow and relative valuation models and should be familiar territory for anyone who has done or read about valuation before. This book has three parts to it. and hope- fully I have gained from my experiences since. In fact. we are all dead. as Keynes would have said.

warts and all. so as to capture some of the problems inherent in applying these models. without a significant loss of continuity. The four basic principles that I laid out in the Preface to the first edition con- tinue to hold on this one. but this cost is well worth the benefits. but the chapter on control should give you a road map that may help you come up with the an- swer on your own. There is the obvi- ous danger that some of these valuations will appear to be hopelessly wrong in hindsight. while presenting the common elements in these models and providing a framework that can be used to pick the right model for any valuation scenario. in keeping with my belief that valuation models are universal and not market-specific. I have tried to make the book as modular as possible. I have attempted to be as comprehensive as possible in covering the range of valuation models that are available to an analyst doing a valuation. First. Third. Finally. New York June 2006 . ASWATH DAMODARAN New York. illustrations from mar- kets outside the United States are interspersed through the book. Sec- ond. enabling a reader to pick and choose sections of the book to read. the models are presented with real-world examples.x PREFACE have the answer to what the value of control should be in a firm.