Introduction

Valuation is more than numbers and models

•There are 3 broad themes in Valuation

• Valuation is simple
• Valuation come with story behind it
• Valuations go bad because of 3 big problems
Problems in valuation

•Bias
•Uncertainty
•Complexity
Why we need to do valuation

• To fight against “lemming” problem

• ”They know something that I don’t”
• You value a company at $50/share, but the
stock is trading at $285/share. What is your
decision?
• We miss something about the company?
Why we need to do valuation

• Proud lemmings = Momentum investors

• Yogi Bear lemmings
• Lemmings with life vests.

Valuation gives you a life vest

Bermuda Triangle in valuation
• Three reasons why valuation fails:
• Preconception of the company
• Who pay you to do the valuation?
• How much you get paid?
Bermuda Triangle in valuation

•Three reasons why valuation fails:

•Misconception about valuation as science
• Am I comfortable with the numbers?
• Am I certain about the numbers?
Esimtates are forecasts for the future with some standard errors.

One of the great ironies in valuation is “the more uncomfortable you feel
valuing a company, the greater the payoff to doing valuation.”
Bermuda Triangle in valuation

•Three reasons why valuation fails:

•Misconception of the more complex models,
the better valuation is.
• As these models get really complex, two things happen:
• These models become black boxes .
• Depend on your input
Bermuda Triangle in valuation

•Three reasons why valuation fails:

•Preconception of the company
•Misconception about valuation as science
•Misconception of the more complex models,
the better valuation is
 Three broad approaches

• Intrinsic valuation
• You value a company based on its fundamentals
• Relative valuation
• You look at what similar assets are being priced at by
the market right now
• Option price valuation
You value an asset which has contingent cash flows
Underlying each approach is an assumption about how markets work: Market makes mistakes
Intrinsic valuation
• Discounted Cash Flow valuation
Intrinsic value of a firm = ∑PV(Cfi)
• Cashflows
• Discount rate
• Life time of the asset

• Note: Assumming market makes mistake -> converge into intrinsic value over time
• You need a long time horizon.
Relative valuation
• Valuing based on how similar assets are priced
• Multiples = scale measure of price
• Find other companies that look like yours
• Control for difference across these companies
• Note: For relative valuation, what kind of mistakes do you assume
markets make?
“Markets are right on average but that they're wrong in individual
companies.”
Option price model
• Option derive the value from an underlying asset
• Contingent payoff
• Limited life