Damodaran: Sixth Myths about Valuation
In his book, Damodaran on Valuation: Security Analysis for Investment and Corporate Finance, Damodaran details sixth myths about valuation. It is worth a share as it hits the nail on the head in terms of the perceptions and misperceptions that most people (including me) have regarding investment valuation.
Myth #1: Since valuation models are quantitative, valuation is objective
How do you know what valuation method to use? This is a very commonly asked question. While I can understand the intent and spirit of the question, valuation is important after all – one should refrain from taking it too far. Reassuring as it may be, just because there is a quantitative output doesn’t mean that it is accurate or objective. It can still be the product of biased-ness.
Myth #2: Well researched and well done valuation is timeless
New information is released all the time. Consequently, valuations are always changing and it is vital to keep abreast of new developments. As long as you have sound reasons, be ruthless in changing your valuations. Do not be held hostage by sentiments.
Myth #3: Good valuation provides a precise estimation of value
Valuation, no matter how rigorous, is never a science. It can be argued that it is the variability around the target valuation which matters. But the bottom line is to never worship a valuation figure as a representation of true intrinsic value.
Myth #4: The more quantitative the better
Throwing in more parameters into a valuation does not necessarily make it better or more accurate. Remember this the next time you see someone tossing in fancy, obscure terms or unjustified numbers in terminal growth or earnings growth.
Myth #5: The market is generally wrong
Do not assume that just because you arrived at a different valuation, you are necessarily smart. The market is efficient much more often than it is not. What makes your analysis so special? It may be worthwhile to ponder if you have left any stones unturned.
Myth #6: The product of valuation matters, not the process
Last but not least, many think that valuation is just about getting that one final number. However, it is actually the process of justifying your parameters and assumptions in order to arrive at the final valuation that is critical. The last thing you want is to extensively research on a company only to plug in an earnings growth parameter into your valuations based on ‘I believe’. The hardest part about valuation is in justifying your ‘beliefs’ – objectively and quantitatively. Any sell-side research analyst will tell you that he is able to come up with any valuation for a single company. It is not about showing off your final valuation number (or in some cases, multiple valuation scenarios) because well, junk in, junk out.