Valuation is at the heart of any investment decision, whether that decision is to buy, sell, or hold. In The Little Book of Valuation, expert Aswath Damodaran explains the techniques in language that any investors can understand, so you can make better investment decisions when reviewing stock research reports and engaging in independent efforts to value and pick stocks.
Page by page, Damodaran distills the fundamentals of valuation, without glossing over or ignoring key concepts, and develops models that you can easily understand and use. As the companies get larger and decide to go public, valuations determine the prices at which they are offered to the market in the public offering. Once established, decisions on where to invest, how much to borrow, and how much to return to the owners will all be decisions that are affected by perceptions of their impact on value.
Even accounting is not immune. The most significant global trend in accounting standards is a shift toward fair value accounting, where assets are valued on balance sheets at their fair values rather than at their original cost. Thus, even a casual perusal of financial statements requires an understanding of valuation fundamentals.
Before delving into the details of valuation, it is worth noting some general truths about valuation that will provide you not only with perspective when looking at valuations done by others, but also with some comfort when doing your own. You almost never start valuing a company or stock with a blank slate.
All too often, your views on a company or stock are formed before you start inputting the numbers into the models and metrics that you use and, not surprisingly, your conclusions tend to reflect your biases. The bias in the process starts with the companies you choose to value. These choices are not random. It may be that you have read something in the press good or bad about the company or heard from a talking head that a particular company was under- or overvalued.
It continues when you collect the information you need to value the firm. The annual report and other financial statements include not only the accounting numbers but also management discussions of performance, often putting the best possible spin on the numbers. With professional analysts, there are institutional factors that add to this already substantial bias.
Equity research analysts, for instance, issue more buy than sell recommendations because they need to maintain good relations with the companies they follow and also because of the pressures that they face from their own employers, who generate other business from these companies.
To these institutional factors, add the reward and punishment structure associated with finding companies to be under- and overvalued. Analysts whose compensation is dependent upon whether they find a firm to be cheap or expensive will be biased in that direction. Availability can change throughout the month based on the library's budget. You can still place a hold on the title, and your hold will be automatically filled as soon as the title is available again.
The OverDrive Read format of this ebook has professional narration that plays while you read in your browser. Learn more here. You've reached the maximum number of titles you can currently recommend for purchase. Your session has expired. Ask yourself: Does it really matter what others think about me? Not loaded yet? The next two sections look at adapting valuation models for different typies of companies - across the life cycle and then across sectors.
The last section has a glossary and links to datasets and spreadsheets. I apologize for errors that have found their way into the print edition. I have a list below of some of them. Value the Business or Just the Equity? In discounted cash flow valuation, you discount expected cash flows back at a risk-adjusted rate. When applied in the context of valuing a company, one approach is to value the entire business, with both existing investments and growth assets; this is often termed firm or enterprise valuation.
The other approach is to focus on valuing just the equity in the business. Table 3. Put in the context of the question of whether you should buy shares in 3M, here are your choices. You can value 3M as a business and subtract out the debt the company owes to get to the value of its shares. Or, you can value the equity in the company directly, by focusing on the cash flows 3M has left over after debt payments and adjusting for the risk in the stock.
Done right, both approaches should yield similar estimates of value per share. Inputs to Intrinsic Valuation There are four basic inputs that we need for a value estimate: cash flows from existing assets net of reinvestment needs and taxes ; expected growth in these cash flows for a forecast period; the cost of financing the assets; and an estimate of what the firm will be worth at the end of the forecast period.
Each of these inputs can be defined either from the perspective of the firm or just from the perspective of the equity investors. We will use 3M to illustrate each measure, using information from September One limitation of focusing on dividends is that many companies have shifted from dividends to stock buybacks as their mechanism for returning cash to stockholders.
One simple way of adjusting for this is to augment the dividend with stock buybacks and look at the cumulative cash returned to stockholders.
With both dividends and augmented dividends, we are trusting managers at publicly traded firms to pay out to stockholders any excess cash left over after meeting operating and reinvestment needs. However, we do know that managers do not always follow this practice, as evidenced by the large cash balances that you see at most publicly traded firms. To estimate what managers could have returned to equity investors, we develop a measure of potential dividends that we term the free cash flow to equity.
Intuitively, the free cash flow to equity measures the cash left over after taxes, reinvestment needs, and debt cash flows have been met. Its measurement is laid out in Table 3. If working capital increases, cash flow decreases. The net change affects cash flows to equity. If it is positive, it represents a potential dividend. If it is negative, it is a cash shortfall that has to be covered with new equity infusions.
To measure reinvestment, we will first subtract depreciation from capital expenditures; the resulting net capital expenditure represents investment in long-term assets. To measure what a firm is reinvesting in its short-term assets inventory, accounts receivable, etc. Adding the net capital expenditures to the change in non-cash working capital yields the total reinvestment.
This reinvestment reduces cash flow to equity investors, but it provides a payoff in terms of future growth. The cash flow to the firm is the cash left over after taxes and after all reinvestment needs have been met, but before interest and principal payments on debt.
Both FCFE and FCFF are after taxes and reinvestment and both can be negative, either because a firm has negative earnings or because it has reinvestment needs that exceed income. Risk Cash flows that are riskier should be assessed a lower value than more stable cash flows. In conventional discounted cash flow valuation models, we use higher discount rates on riskier cash flows and lower discount rates on safer cash flows. The definition of risk will depend upon whether you are valuing the business or just the equity.
When valuing equity, you look at the risk in the equity investment in this business, which is partly determined by the risk of the business the firm is in and partly by its choice on how much debt to use to fund that business. The equity in a safe business can become risky, if the firm uses enough debt to fund that business.
In discount rate terms, the risk in the equity in a business is measured with the cost of equity, whereas the risk in the business is captured in the cost of capital. The latter will be a weighted average of the cost of equity and the cost of debt, with the weights reflecting the proportional use of each source of funding. There are three inputs needed to estimate a cost of equity: a risk-free rate and a price for risk equity risk premium to use across all investments, as well as a measure of relative risk beta in individual investments.
Equity risk premium ERP : This is the premium investors demand on an annual basis for investing in stocks instead of a risk-free investment, and it should be a function of how much risk they perceive in stocks and how concerned they are about that risk. To estimate this number, analysts often look at the past; between and , for instance, stocks generated 4.
An alternative is to back out a forward-looking premium called an implied equity risk premium from current stock price levels and expected future cash flows. In January , the implied equity risk premium in the United States was approximately 5 percent. As a consequence, the beta estimates that we obtain will always be backward looking since they are derived from past data and noisy since they are estimated with error. One solution is to replace the regression beta with a sector-average beta, if the firm operates in only one business or a weighted average of many sector betas if the firm operates in many businesses.
The sector beta is more precise than an individual regression beta because averaging across many betas results in averaging out your mistakes. In September , the risk-free rate was set to the year Treasury bond rate of 3. The resulting beta is 1. It is to cover this default risk that lenders add a default spread to the riskless rate when they lend money to firms; the greater the perceived risk of default, the greater the default spread and the cost of debt.
Once you have a bond rating, you can estimate a default spread by looking at publicly traded bonds with that rating. In September , we computed an interest coverage ratio of The final input needed to estimate the cost of debt is the tax rate. Since interest expenses save you taxes at the margin on your last dollars of income , the tax rate that is relevant for this calculation is the tax rate that applies to those last dollars or the marginal tax rate.
In the United States, where the federal corporate tax rate is 35 percent and state and local taxes add to this, the marginal tax rate for corporations in was close to 40 percent.
Bringing together the risk-free rate 3. For publicly traded firms, multiplying the share price by the number of shares outstanding will yield market value of equity. Estimating the market value of debt is usually a more difficult exercise, since most firms have some debt that is not traded and many practitioners fall back on using book value of debt.
If we assume that they will change, we have to specify both what the target mix for the firm will be and how soon the change will occur. Growth Rates When confronted with the task of estimating growth, it is not surprising that analysts turn to the past, using growth in revenues or earnings in the recent past as a predictor of growth in the future.
However, the historical growth rates for the same company can vary, depending upon computational choices: how far back to go, which measure of earnings net income, earnings per share, operating income to use, and how to compute the average arithmetic or geometric. With 3M, for instance, the historical growth rates range from 6 percent to 12 percent, depending upon the time period 1, 5, or 10 years and earnings measure earnings per share, net income, or operating income used.
Worse still, studies indicate that the relationship between past and future growth for most companies is a very weak one, with growth dropping off significantly as companies grow and revealing significant volatility from period to period. On the plus side, these forecasters should have access to better information than most investors do.
On the minus side, neither managers nor equity research analysts can be objective about the future; managers are likely to overestimate their capacity to generate growth and analysts have their own biases. Studies indicate that analyst and management estimates of future growth, especially for the long term, seem just as flawed as historical growth rates.
If historical growth and analyst estimates are of little value, what is the solution? Ultimately, for a firm to grow, it has to either manage its existing investments better efficiency growth or make new investments new investment growth. To capture efficiency growth, you want to measure the potential for cost cutting and improved profitability.
It can generate substantial growth in the near term, especially for poorly run mature firms, but not forever. To measure the growth rate from new investments, you should look at how much of its earnings a firm is reinvesting back in the business and the return on these investments. While reinvestment and return on investment are generic terms, the way in which we define them will depend upon whether we are looking at equity earnings or operating income.
With equity earnings, we measure reinvestment as the portion of net income not paid out as dividends retention ratio and use the return on equity to measure the quality of investment. With operating income, we measure reinvestment as the reinvestment rate and use the return on capital to measure investment quality.
In Table 3. We estimate the expected cash flows to 3M for the next five years in Table 3. Since we cannot estimate cash flows forever, we generally impose closure in valuation models by stopping our estimation of cash flows sometime in the future and then computing a terminal value that reflects estimated value at that point.
If we assume that the business will be ended in the terminal year and that its assets will be liquidated at that time, we can estimate the proceeds from the liquidation, using a combination of market-based numbers for assets such as real estate that have ready markets and estimates. For firms that have finite lives and marketable assets, this represents a fairly conservative way of estimating terminal value. If we treat the firm as a going concern at the end of the estimation period, we can estimate the value of that concern by assuming that cash flows will grow at a constant rate forever afterwards.
This perpetual growth model draws on a simple present value equation to arrive at terminal value: The definitions of cash flow and growth rate have to be consistent with whether we are valuing dividends, cash flows to equity, or cash flows to the firm; the discount rate will be the cost of equity for the first two and the cost of capital for the last. Since the terminal value equation is sensitive to small changes and thus ripe for abuse, there are three key constraints that should be imposed on its estimation: First, no firm can grow forever at a rate higher than the growth rate of the economy in which it operates.
In fact, a simple rule of thumb on the stable growth rate is that it should not exceed the risk-free rate used in the valuation; the risk-free rate is composed of expected inflation and a real interest rate, which should equate to the nominal growth rate of the economy in the long term. Second, as firms move from high growth to stable growth, we need to give them the characteristics of stable growth firms; as a general rule, their risk levels should move towards the market beta of one and debt ratios should increase to industry norms.
Third, a stable growth firm should reinvest enough to sustain the assumed growth rate. Given the relationship between growth, reinvestment rate, and returns that we established in the section on expected growth rates, we can estimate this reinvestment rate: Thus, the effect on the terminal value of increasing the growth rate will be partially or completely offset by the loss in cash flows because of the higher reinvestment rate. Whether value increases or decreases as the stable growth rate increases will entirely depend upon what you assume about the return on investment.
If the return on capital equity is higher than the cost of capital equity in the stable growth period, increasing the stable growth rate will increase value. If the return on capital is equal to the stable period cost of capital, increasing the stable growth rate will have no effect on value. The key assumption in the terminal value computation is not what growth rate you use in the valuation, but what excess returns accompany that growth rate.
There are some analysts who believe that zero excess return is the only sustainable assumption for stable growth, since no firm can maintain competitive advantages forever. In practice, though, firms with strong and sustainable competitive advantages can maintain excess returns, though at fairly modest levels, for very long time periods.
Using 3M, we assumed that the firm would be in stable growth after the fifth year and grow 3 percent a year forever set at the risk-free rate.
As the growth declines after year five, the beta is adjusted towards one and the debt ratio is raised to the industry average of 20 percent to reflect the overall stability of the company. Since the cost of debt is relatively low, we leave it unchanged, resulting in a drop in the cost of capital to 6. The after-tax operating income in year 6 is obtained by growing the income in year 5 by 3 percent. Discounting this terminal value and the cash flows from Table 3.
If you discounted dividends or free cash flows to equity on a per-share basis at the cost of equity, you have your estimate of value per share.
If you discounted cash flows to the firm, you have four adjustments to make to get to value per share: 1. Add back the cash balance of the firm: Since free cash flow to the firm is based upon operating income, you have not considered the income from cash or incorporated it into value. Adjust for cross holdings: Add back the values of small minority holdings that you have in other companies; the income from these holdings was not included in your cash flow.
You have to subtract out the estimated market value of the minority interest from your consolidated firm value. Subtract other potential liabilities: If you have underfunded pension or health care obligations or ongoing lawsuits that may generate large liabilities, you have to estimate a value and subtract it out. Subtract the value of management options: When companies give options to employees, analysts often use short cuts such as adjusting the number of shares for dilution to deal with these options.
The right approach is to value the options using option pricing models , reduce the value of equity by the option value, and then divide by the actual number of shares outstanding. What if the intrinsic value that you derive, from your estimates of cash flows and risk, is very different from the market price?
There are three possible explanations. A second and related explanation is that you have made incorrect assessments of risk premiums for the entire market. A third is that the market price is wrong and that you are right in your value assessment.
Even in the last scenario, there is no guarantee that you can make money from your valuations. For that to occur, markets have to correct their mistakes and that may not happen in the near future. In fact, you can buy stocks that you believe are undervalued and find them become more undervalued over time.
That is why a long time horizon is almost a prerequisite for using intrinsic valuation models. Giving the market more time say three to five years to fix its mistakes provides better odds than hoping that it will happen in the next quarter or the next six months.
While the stock looks undervalued, the degree of undervaluation less than 10 percent is well within the margin of error in the valuation. Hence, I did not feel the urge to buy at the time.
The intrinsic value of a company reflects its fundamentals. Estimates of cash flows, growth, and risk are all embedded in that value, and it should have baked into it all of the other qualitative factors that are often linked to high value, such as a great management team, superior technology, and a long-standing brand name. There is no need for garnishing in a well-done intrinsic valuation.
Is Dell cheaper than Apple? Is Microsoft a bargain compared to both Apple and Dell? Are they even similar companies? Relative valuation is all about comparing how the market prices different companies, with the intent of finding bargains.
In relative valuation, you value an asset based on how similar assets are priced in the market. A prospective house buyer decides how much to pay for a house by looking at the prices paid for similar houses in the neighborhood. The three essential steps in relative valuation are: 1. Find comparable assets that are priced by the market.
Scale the market prices to a common variable to generate standardized prices that are comparable across assets 3. Adjust for differences across assets when comparing their standardized values.This downloadd site is designed to support "The Little Book of Valuation". The publisher is John Wiley and Sons. Since it is one of four books that I have on valuation, it behooves me to explain how this book is different from my rest and I attempt to do so here. Once you have got that out of the way, you can get a quick review of the tools that make up the valuation toolkit and then move on to valuation inputs and mechanics. The next two sections look at adapting valuation models for different typies of companies - across the life cycle and then across sectors. The last section has a glossary and links the little book of valuation free download datasets and spreadsheets. I apologize for errors that have found the little book of valuation free download way into the print edition. I have a list below of some of them. If you find more, I would like to add them to the list. Intuition behind the time value of littpe Discounting mechanics. Descriptive Statistiics The little book of valuation free download Relationships. Free tour en alcala de henares Value Drivers. Capitalizing intangible expenses Adjusting equity value for options outstanding. Intrinsic versus Relative Value. Present Value Calculator. Financial Ratio Calculator. Margins by sector. Historical growth rates by sector Fundamental growth rates in equity earnings by sector The little book of valuation free download growth rates in operating income by sector. Books in the Little Book Big Profits series include: The Little Book That Still Beats the Market Valuation is at the core of the economic activity in a free economy. genericpills24h.com: The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit Get your Kindle here, or download a FREE Kindle Reading App. Valuation is at the heart of any investment decision, whether that decision is to buy, sell, or hold. In The Little Book of Valuation, expert Aswath Damodaran. Read The Little Book of Valuation by Aswath Damodaran with a free trial. Read unlimited* books and audiobooks on the web, iPad, iPhone and Android. The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit After you've bought this ebook, you can choose to download either the PDF this book in encrypted form, which means that you need to install free software in. This web site is designed to support "The Little Book of Valuation". The publisher is John Wiley and Sons. Since it is one of four books that I have on valuation. In The Little Book of Valuation, expert Aswath Damodaran explains the techniques in language that any Page by page, Damodaran distills the fundamentals of valuation, without glossing over or ignoring key Download Product Flyer. Read "The Little Book of Valuation How to Value a Company, Pick a Stock and Profit" by Aswath Damodaran available from Rakuten Kobo. An accessible, and intuitive, guide to stock valuation Valuation is at the heart Free with Trial ISBN: ; Language: English; Download options: EPUB 2 (Adobe DRM). valuation described in this book attempt to relate value to the level and expected growth At one end of the spectrum, you have the default-free zero use to value unique firms, with no obvious comparables, with little or no revenues and. Read Books Online For Free. Online Library At Your Fingertips With ReadingFanatic App. As the firm matures, Table 5. Page by page, Damodaran distills the fundamentals of valuation, without glossing over or ignoring key concepts, and develops models that you can easily understand and use. Hence, I did not feel the urge to buy at the time. ET Magazine. The cash flow to the firm is the cash left over after taxes and after all reinvestment needs have been met, but before interest and principal payments on debt. This reinvestment reduces cash flow to equity investors, but it provides a payoff in terms of future growth. Growth Rates When confronted with the task of estimating growth, it is not surprising that analysts turn to the past, using growth in revenues or earnings in the recent past as a predictor of growth in the future. Valuation Solutions In this section, we will begin by laying out the foundations for estimating the intrinsic value of a young company, move on to consider how best to adapt relative valuation for the special characteristics of young companies, and close with a discussion of how thinking about investments in these companies as options can offer valuation insights. Abc Large. Definitional Tests Even the simplest multiples are defined and computed differently by different analysts. Once established, decisions on where to invest, how much to borrow, and how much to return to the owners will all be decisions that are affected by perceptions of their impact on value.