Valuation | The Overarching Idea
"Every Story has a Number and Every Number has a Story" - Aswath Damodaran
1. Key Themes in Valuation
2. Three Common Valuation Approaches
3. Understanding Market Behavior Assumptions
Each approach makes certain assumptions about how markets behave:
4. Choosing the Right Approach for the Context
- 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.
- Storytelling matters: A good valuation goes beyond just crunching numbers. It considers the narrative behind the business, its potential, and the risks involved.
- Perfection is unattainable: Numbers are mere estimates, and there's no such thing as a perfect valuation. Focus on making informed judgments based on available data and assumptions.
- Beware of biases: Our own biases and market trends can skew our valuations. Strive for objectivity by acknowledging and mitigating these biases.
2. Three Common Valuation Approaches
- Intrinsic Valuation: This approach focuses on the inherent value of a business based on its fundamentals like cash flows, growth, and risk. Discounted cash flow (DCF) is a popular method here.
- Relative Valuation: This approach compares a business to similar businesses in the market to determine its value. Price-to-earnings (P/E) ratio is a common metric used.
- Option Pricing: This approach uses complex models to value assets with uncertain payoffs, like undeveloped resources or patents.
3. Understanding Market Behavior Assumptions
Each approach makes certain assumptions about how markets behave:
- Intrinsic valuation: Assumes markets make mistakes but eventually correct them.
- Relative valuation: Assumes markets are generally right but can misjudge individual companies.
- Option pricing: Assumes markets are efficient but struggle with pricing uncertain assets.
4. Choosing the Right Approach for the Context
- Stable businesses with predictable cash flows: Intrinsic valuation might be suitable.
- Comparing similar businesses in a growing industry: Relative valuation might be more relevant.
- Valuing assets with uncertain potential: Option pricing could be an option.
- 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.