Professional Documents
Culture Documents
AN INTRODUCTION TO
VALUATION
Spring 2020
Aswath Damodaran
Valuation won’t make you rational. You are
a human being with lemmingitis!
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The Bermuda Triangle of Valuation
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Valuation First
Bi
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Principles &
els
Good Sense
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Basis for all valuation approaches
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Advantages of DCF Valuation
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Disadvantages of DCF valuation
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When DCF Valuation works best
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Relative Valuation (Pricing)
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Advantages of Relative Valuation
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¨ In sync with the market: Relative valuation is much more likely to reflect
market perceptions and moods than discounted cash flow valuation. This
can be an advantage when it is important that the price reflect these
perceptions as is the case when
¤ the objective is to sell an asset at that price today (IPO, M&A)
¤ investing on “momentum” based strategies
¨ With relative valuation, there will always be a significant proportion of
securities that are under valued and over valued. Since portfolio
managers are judged based upon how they perform on a relative basis (to
the market and other money managers), relative valuation is more
tailored to their needs
¨ Relative valuation generally requires less explicit information than
discounted cash flow valuation.
¨ In relative valuation, you are playing the “incremental” game, where you
hope to make money by getting the next increment (earnings report,
news story etc.) right.
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Disadvantages of Relative Valuation
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When relative valuation works best..
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And there are some investments that can
only be priced
To value To price
Assets Can be valued based upon Can be priced against
expected cashflows, with similar assets, after
higher cashflows & lower controlling for cash flows
risk = higher value. and risk.
Commodity Can be valued based upon Can be priced against its
utilitarian demand and own history (normalized
supply, but with long lags price over time)
in both.
Currency Cannot be value Can be priced against
other currencies, with
greater acceptance & more
stable purchasing power =
higher price.
Collectible Cannot be value Can be priced based upon
scarcity and desirability.
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Asset Based Valuation: A Detour
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Contingent Claim (Option) Valuation
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Option Payoff Diagrams
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Put Option
Call Option
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Direct Examples of Options
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Indirect Examples of Options
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In summary…
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