Valuation | Relative Valuation
"Every Story has a Number and Every Number has a Story" - Dr. Aswath Damodaran

1. Introduction to Relative Valuation:

• Damodaran begins by contrasting relative valuation with intrinsic valuation. While intrinsic valuation focuses on an asset's value based on its fundamentals (cash flows, growth, and risk), relative valuation values an asset based on how similar assets are priced.
• He emphasizes that most analysts prefer relative valuation, often using it incorrectly. To address this, he introduces a four-step process to ensure a more accurate and reliable application of relative valuation.

2. The Four-Step Process:

• Define the Multiple: It's crucial to start with a clear and consistent definition of the multiple being used. For instance, the Price/Earnings (P/E) ratio should have a consistently defined numerator (price) and denominator (earnings).
• Describe the Multiple: This involves understanding the statistical properties of the multiple, like its distribution, median, and range. This step helps identify what's considered high, low, or average for the multiple.
• Analyze the Multiple: Here, the goal is to understand what drives the multiple. This involves breaking down the multiple into its components and seeing how changes in fundamentals like cash flows, growth, and risk affect the multiple.
• Apply the Multiple: The final step is the practical application, where you use the multiple to value a company. This involves choosing comparable firms carefully, considering not just industry but also fundamentals like cash flows, growth, and risk.

3. Challenges and Considerations:

• Damodaran discusses the common pitfalls in using multiples, such as inconsistent definitions and not accounting for differences between companies. He stresses the importance of understanding the variables that drive multiples and how to control for differences when comparing firms.

4. The Prevalence of Relative Valuation:

• The lecture highlights the widespread use of relative valuation in the industry, noting that it's often preferred due to its simplicity and the ease of making comparisons. However, he warns against its misuse and the dangers of relying solely on multiples without understanding the underlying assumptions.

5. The Appeal of Relative Valuation:

• Relative valuation is more intuitive and easier to communicate, making it a popular choice among analysts. It's also easier to defend as the assumptions are implicit, unlike in intrinsic valuation where assumptions are explicit and open to scrutiny.

​- I try to study Dr. Aswath Damodaran and all my Valuation articles are motivated from insights and teachings from Dr. Aswath Damodaran. So, all credits to Dr. Damodaran and his teaching style.