Here’s number three in our series of lessons from Aswath Damodaran’s three day course on valuation for executives at the Stern School of Business at NYU.Something that Aswath Damodaran reiterated frequently during his lecture is that valuation is not some sort of magical, objective science that will let you know what others don’t. It provides an anchor for your thinking and investment behaviour.
All valuations are biased, and the direction and size of that bias are directly related to how you feel about a company, and who’s paying for the work.
Here are the three biggest myths of valuation from Professor Damodaran’s presentation:
- A valuation is an objective search for true value
- A good valuation provides a precise estimate of value
- The more quantitative a model, the better the valuation
Here’s the anecdote Professor Damodaran told to illustrate the first point:
“I have valued Microsoft every year since 1986, the year of their IPO. 26 years in a row. Every year through 2011 when I valued Microsoft I found it to be overvalued. You name the price, I found it overvalued. $2, $4, $8, “don’t buy, don’t buy, don’t buy.” Strange right? One of the great success stories of US equity markets over the last 50 years, and I wouldn’t have touched it one step of the way. Now I can give you access to every one of those models… You can dig through these models looking for clues as to why I found Microsoft to be overvalued, but you’d be looking in the wrong place. If you really want to know why I found Microsoft to be overvalued all of these years, all you need to do is walk up my office and look around. What you’re going to see is a bunch of computers with fruits on the back.”
You choose the numbers that go into a valuation. Write down your biases beforehand. Your valuation, and your interpretation of the results will benefit.
Thanks to Stern Executive Education for allowing us to attend the lecture
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