Mittwoch, 21. Juli 2010

Valuation Approaches

Aswath Damodaran on "Valuation Approaches":

I have always believed that valuation is simple at its core and that we choose to make it complex. Furthermore, the determinants of value have not changed through the ages; all that has changed are the estimation practices. One of my pet peeves relating to valuation is when an entity (usually a consultant, academic or an appraiser) takes a standard valuation equation, does some algebra, moves terms around and then claims to have discovered a new and "better" valuation model.

Each consulting firm has its own proprietary value measure, with a fancy name and acronym (Economic value added (EVA), Cash Flow Return on Investment (CFROI), Cash Return on Capital Invested (CROCI) etc.) that it markets to its clients as the magic bullet for value creation. To make themselves indispensable, consultants usually add computational twists that require their presence. To get a sense of how these measures are marketed, you can check out books on each (usually written by the measure's developers):
All of these models share two themes. First, they relate the value of a business to excess returns (returns earned over and above the cost of capital or equity). Second, each claims to be easier to use, more intuitive and better than the other models out there.

With analysts, the search for a better valuation approach usually takes the form of concocting new multiples or modifying existing ones. Consider the PEG ratio, a favored tool of analysts following high tech (and growth) companies. The PEG ratio is obtained by dividing the PE ratio by the expected growth rate in earnings per share, and companies that trade at low PEG ratios are considered cheap. It is viewed as a less time-intensive and assumption-free substitute for intrinsic valuation.

As analysts and consultants push their favored approaches to the forefront, it is no surprise that most of us feel overwhelmed by the choices that we face. Which of these dozens of approaches will yield the right value? How do I pick? At the risk of being simplistic, let me offer a solution. Pick the approach that you feel most comfortable with and use it correctly. The value you obtain will be identical to the value you would have obtained using any alternate approach. I have an extended survey paper that I wrote on valuation approaches (and their history) in 2005 that can be downloaded online, if you are interested:
Valuation is not rocket science. Valuing companies may not be easy but the challenges we face are not in valuation theory but in estimation practice. Put another way, we know exactly how to value companies. What we do not have a handle on is how best to estimate growth, risk and cash flows. So, let's stop concocting new models and theories and start thinking more seriously about how best to estimate cash flows for a cyclical firm, risk for a regulated company and growth for young start-up firm. The second edition of one of my books, The Dark Side of Valuation, is dedicated to this concept. You may not like or agree with some of the solutions that I have to estimation challenges, but I hope it will start you thinking about how best to deal with these challenges. 

Keine Kommentare:

Kommentar veröffentlichen