Valuation

10/03/2014

2 types of valuation: intrinsic and relative

intrinsic value of asset: deter. by cash flow you expect that asset
to generate over its life and how uncertain you feel about these
cash flows
o assets with high and sable flows should be worth more
than assets with low and volatile cash flows
o pay more for a property with long term renters paying high
rent than one with lower rental income and variable
vacancy rates from period to period.
Relative value: value relative to its peers
o Stock to buy if it is trading 8 times earning while other
peers 12 times earnings
Biases
o Inputs use in valuation reflect optimistic or pessimistic
bentmight use higher growth rates and see less risks in
companies we like
o Careful of Post-valuation garnishingincrease your
estimated value by adding premiums for good stuff or
reduce estimated value for bad stuff
o Always be honest about biases
Why pick this company to value? Do u like/dislike
companys management? Do u own stock in
company?
o Confine background research to information sources rather
than opinion sources, i.e., spend more time looking at
companys financial statements than reading equity
research reports about the company.
o If using someone elses valuation check for potential
biasesmore bias, less weight to judgment
Most valuations are wrong:
o If info sources are impeccable, u have to convert raw info
into forecasts---estimation error
o Path envisioned for company can prove hopelessly off
firm-specific uncertainty
o Use simplest model possible to valueif you can value an
asset with 3 inputs dont use 5if you can value with 3
years of forecasts , dont forecast 10
Success in investing comes not from being right but being wrong
less often than everyone else

Time is money
o Cash flow in the future is worth less than a similar cash
flow today
People prefer consuming today to consuming in the
future

Inflation decreases the purchasing power of cash

over time. A dollar in the future will buy less than a
dollar would today
A promised cash flow in the future may not be
delivered. Risk in waiting