Aswath Damodaran - Damodaran on Valuation

Contents

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Copyright 2006 by Aswath Damodaran. All rights reserved.

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Library of Congress Cataloging-in-Publication Data:

Damodaran, Aswath.

Damodaran on valuation : security analysis for investment and corporate finance / Aswath Damodaran.2nd ed.

p. cm.(Wiley finance series) Includes index.

ISBN-13 978-0-471-75121-2 (cloth) ISBN-10 0-471-75121-9 (cloth)

1. CorporationsValuationMathematical models. 2. Capital assets pricing model. 3. Investment analysis. I. Title. II. Series.

HG4028.V3D35 2006 658.15dc22

2006004905

To all those people with whom

I have debated valuation issues over time

and who have pointed out the errors

(or at least the limitations)

of my ways

Preface

There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world.

John Maynard Keynes

Lord Keynes was not alone in believing that the pursuit of true value based on financial fundamentals is a fruitless one in markets where prices often seem to have little to do with value. There have always been investors in financial markets who have argued that market prices are determined by the perceptions (and misperceptions) of buyers and sellers, and not by anything as prosaic as cash flows or earnings. I do not disagree with them that investor perceptions matter, but I do disagree with the notion that they are all that matter. It is a fundamental precept of this book that it is possible to estimate value from financial fundamentals, albeit with error, for most assets, and that the market price cannot deviate from this value in the long term. From the tulip bulb craze in Holland in the early seventeenth century to the South Sea Bubble in England in the 1800s to the stock markets of the present, markets have shown the capacity to correct themselves, often at the expense of those who believed that the day of reckoning would never come.

The first edition of this book was my first attempt at writing a book, and hopefully I have gained from my experiences since. In fact, this edition is very different from the prior edition for a simple reason. My other book on investment valuation, also published by John Wiley & Sons, was designed to be a comprehensive valuation book, and repeating what was said in that book here, in compressed form, strikes me as a waste of time and resources.

This book has three parts to it. The first two parts, which stretch through the first nine chapters, provide a compressed version of both discounted cash flow and relative valuation models and should be familiar territory for anyone who has done or read about valuation before. The third part, which comprises the last nine chapters, is dedicated to looking at what I call the loose ends in valuation that get short shrift in both valuation books and discussions. Included here are topics like liquidity, control, synergy, transparency, and distress, all of which affect valuations significantly but either are dealt with in a piecemeal fashion or take the form of arbitrary premiums and discounts. You will notice that this section has more references to prior work in the area and is denser, partly because there is more debate about what the evidence is and what we should do in valuation. I do not claim to have the answer to what the value of control should be in a firm, but the chapter on control should give you a road map that may help you come up with the answer on your own.

The four basic principles that I laid out in the Preface to the first edition continue to hold on this one. First, I have attempted to be as comprehensive as possible in covering the range of valuation models that are available to an analyst doing a valuation, while presenting the common elements in these models and providing a framework that can be used to pick the right model for any valuation scenario. Second, the models are presented with real-world examples, warts and all, so as to capture some of the problems inherent in applying these models. There is the obvious danger that some of these valuations will appear to be hopelessly wrong in hindsight, but this cost is well worth the benefits. Third, in keeping with my belief that valuation models are universal and not market-specific, illustrations from markets outside the United States are interspersed through the book. Finally, I have tried to make the book as modular as possible, enabling a reader to pick and choose sections of the book to read, without a significant loss of continuity.

Aswath Damodaran

New York, New York

June 2006

But then again, as Keynes would have said, In the long term, we are all dead.