Photo: 20th Century Fox
This is the fourth in our series of lessons from Aswath Damodaran’s three day course on valuation for executives at the Stern School of Business at NYU.One of Professor Damodaran’s three biggest myths about valuation is that “the more quantitative a model, the better the valuation.”
Here’s why you need to rein in the “geek squad.” From the lecture:
…God help you if you have a team in the basement whose job it is to build models. You know what I’m talking about? The geek squad. You hire these software engineers and send them down to the basement, always down to the basement… They love building models. They like to write macros on top of macros on top of macros. Inputs come in and they never leave. The model starts with 12 inputs, then 15, 20, 25, 30, its like they’re having babies. Before you know it there’s this 85 input model to value a company.
Professor Damodaran sees two big problems with these models.
The first is input fatigue. What happens when its midnight and some beleaguered analyst has 76 inputs to enter? They might start to enter a few random numbers. If the model is big enough, it won’t even matter to the final number
The second reason- complicated models are used to avoid analysis. From the lecture:
“I still remember a conversation I had about 15 years ago with an equity research analyst. He put a buy recommendation on a stock, a stock that I was planning to value. I saw a target price of $85, the stock was at $35, I was surprised that he got such a high price. “How come you came up with such a high target price, why do you think the company is worth so much?” He said: “I didn’t do it!” But the report said $85. “I didn’t do it.” “Who did it?”. He said “Valuemag did it.” I said “Who the heck is Valuemag?” “That’s our in-house valuation model.” I said “What did it do? Sneak into your office in the middle of the night, value the company, and leave it on your desk?” But you know what he was trying to tell me in an indirect way? I have this really complicated model called Valuemag, it asks me for numbers, I feed it the numbers, it asks me to go get a cup of coffee, and by the time I come back there’s the answer. “It’s not my fault, the model valued the company at…” Watch for those words, if you ever them in a report “the model valued the company at…” That’s saying “Hey, I just work the model.” Its amazing how with complex models you turn over responsibility.
Add detail to your model, but only if it adds value.
Thanks to Stern Executive Education for allowing us to attend the lecture
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