Introduction to Valuation
Learning objectives:
To discuss the basic concepts of valuation
To identify the philosophical basis for valuation, as well as
examine the myths that come with it
To discuss the role of valuation
Introduction to Valuation
Every asset has value, regardless of type
A resource with economic value that provides future benefits
(generates cash, reduce expense or improve sales)
Bought or created, it increases a firm’s value or benefits its operations
Any asset can be valued, but some assets are easier to value
than others and the details of valuation will vary from case to
case. (e.g. real estate property and publicly traded stocks)
Not all are uniformly measured or no common basis of
measurement.
Uncertainty is always present
Philosophical Basis of Valuation
A postulate of sound investing is that, an investor does not
pay more for an asset than its worth.
The price paid for any asset should reflect the cashflows that
it is expected to generate.
Myths About Valuation
Myth:
Since valuations are quantitative, valuation is objective.
Truth:
All valuations are biased. The only questions are how much
and in which direction. Analysts would look at:
Business management
Capital structure
Future earnings
Market value of assets
Etc.
The direction and magnitude of the bias in your valuation is
directly proportional to who pays you and how much you are
paid.
Myths About Valuation
Myth:
A well-researched and well-done valuation is timeless.
Truth:
A valuation done on a firm ages quickly, and has to be
updated to reflect current information.
Changing market information
Efficient Market Hypothesis (EMH by Samuelson and Fama)
May affect a specific firm, industry sector or worldwide
Myths About Valuation
Myth:
A good valuation provides a precise estimate of value.
Truth:
There are no precise valuations.
Based on estimates like future cash flows or discount rates
A mature company with long history vs young company
Companies in emerging markets vs developed markets
The payoff to valuation is greatest when valuation is least
precise. (and why do you think so?)
Myths About Valuation
Myth:
The more quantitative a model is, the better the valuation.
Truth:
One’s understanding of a valuation model is inversely
proportional to the number of inputs required for the model.
A complex model of valuation requires more inputs which may lead to
potential input errors.
Blame gets attached to the complex model rather than the analyst
Simpler valuation models do much better than complex ones.
Myths About Valuation
Myth:
To make money on valuation, you have to assume that
markets are inefficient.
Truth:
We start from the presumption that the market is correct and
we have to convince ourselves that this is not the case before
we conclude that something is over or undervalued.
Role of Valuation
Valuation and Portfolio Management
Passive investor (long-term profitability) – minimal role
Active investor (short-term gains) – larger role
Fundamental analysts
Underlying theme: true value of the firm can be related to its
financial characteristics – growth prospects, risk profile and
cash flows
Long-term investment strategy
Assumptions are:
The relationship between value and the underlying
financial factors can be measured.
The relationship is stable over time.
Deviations from the relationship are corrected in a
reasonable time period.
Franchise buyer
“We try to stick to businesses we believe we understand.
That means, they must be relatively simple and stable in
character.”
Long-term strategy
Underlying assumptions are:
Investors who understand a business well are in a better
position to value it correctly.
These undervalued businesses can be acquired without
driving the price above the true value.
Chartists
prices are driven as much by investor psychology
Assumptions here are:
prices move in predictable patterns
there are not enough marginal investors taking advantage
of these patterns to eliminate them
the average investor in the market is driven more by
emotion rather than by rational analysis.
Information traders
Information traders attempt to trade in advance of new
information or shortly after it is revealed to financial markets,
buying on good news and selling on bad
Underlying assumption:
traders can anticipate information announcements and
gauge the market reaction to them better than the average
investor in the market.
Market timers
Market timers argue that it is easier to predict market
movements than to select stocks and that these predictions
can be based upon factors that are observable.
Market timing strategies can use valuation in at least two
ways:
The overall market itself can be valued and compared to
the current level.
A valuation model can be used to value all stocks, and the
results from the cross-section can be used to determine
whether the market is over or undervalued.
Efficient marketers
Efficient marketers believe that the market price at any point
in time represents the best estimate of the true value of the
firm, and that any attempt to exploit perceived market
efficiencies will cost more than it will make in excess profits.
For efficient marketers, valuation is a useful exercise to
determine why a stock sells for the price that it does.
Role of Valuation
Valuation in Acquisition Analysis
The following are the special factors to consider in takeover
valuation:
The effects of synergy on the combined value of the two firms
(target plus bidding firm)
The effects on value, of changing management and
restructuring the target firm, will have to be taken into
account in deciding on a fair price (hostile takeovers)
Role of Valuation
Valuation in Corporate Finance
If the objective in corporate finance is the maximization of
firm value, the relationship among financial decisions,
corporate strategy and firm value has to be delineated. In
recent years, management consulting firms have started to
offer advice on how to increase value.
The value of the firm can be directly related to decisions that
it makes – on which projects it takes, on how it finances them
and on its dividend policy. Understanding this relationship is
key to making value-increasing decisions and to sensible
financial restructuring.
End of Presentation
Thank You
Any questions?
References:
https://www.investopedia.com/terms/a/asset.asp
https://www.ruleoneinvesting.com/blog/how-to-invest/warre
n-buffett-quotes-on-investing-success/
https://www.reuters.com/companies/PG.N/profile
https://www.wsj.com/market-data/quotes/PG
https://www.wsj.com/market-data/quotes/PH/XPHS/JFC/advanced-chart
