Finance
by Aswath Damodaran
What is anything actually worth?
Aswath Damodaran teaches valuation at New York University's Stern School, and Investment Valuation is his reference book on the subject. He starts from the view that any asset can be valued, from a steel mill to a loss-making start-up, and that price and value can drift far apart.
Hear a sample · read by Laura
Damodaran sorts every method into three families. Discounted cash flow values an asset on its own cash flows and risk. Relative valuation prices it against similar assets, using multiples such as the price-to-earnings (PE) ratio. Option pricing values assets whose worth depends on something that may or may not happen.
In a discounted cash flow valuation, an asset is worth the cash it will produce, adjusted for when that cash arrives and how uncertain it is. Most arguments about a company's value come down to different views of its cash flows, how fast they'll grow and how risky they are.
Damodaran ties growth to reinvestment. Expected growth equals the share of profit a firm reinvests times the return it earns on it. A company that wants to grow has to spend money to do it, and growth adds value only when the return on capital beats the cost of capital.
Some assets are worth more than their expected cash flows suggest, because they give the owner a choice. A patent's owner can wait until the product makes sense, and an oil company can leave a field undeveloped until prices rise. Damodaran values these choices with option pricing models.
A PE ratio looks simple, but it quietly assumes a rate of growth and a level of risk. Damodaran's four steps for using any multiple are to define it consistently, describe how it varies across firms, analyse what drives it, and only then apply it to a comparison.
Cash flows
A business is worth the cash it will produce in future, adjusted for time and risk.
Risk
Risky cash is worth less than safe cash, so the riskier the business, the harder you discount its future.
Growth
Growth only adds value when the business earns more on new money than that money costs.
Terminal value
Most of a company's value usually sits in the years after your forecast ends, so take care there.
Multiples
Pricing a firm off its peers only works if you allow for how they differ in growth and risk.
Hot take · true or myth?
A well-done valuation stays valid for years.
Myth. Value changes as new information about the company and the wider economy arrives. Damodaran says a valuation has to be updated as that information comes in.
One thing to try
Pick a company you follow. Write one line each on what you expect of its cash flows, their growth and their risk, and one on how it will pay for that growth. If you can't fill in a line, you don't have a valuation yet.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. Investment Valuation comes with a Hot Take round and a Spot the Trap case to make it stick.
Get the whole book on KnotdOpen in the appWhat is anything actually worth? Aswath Damodaran teaches valuation at New York University's Stern School, and Investment Valuation is his reference book on the subject. He starts from the view that any asset can be valued, from a steel mill to a loss-making start-up, and that price and value can drift far apart.
Three ways to value; Cash flows, growth and risk; Growth has to be paid for; Options inside assets; Multiples hide assumptions.
Pick a company you follow. Write one line each on what you expect of its cash flows, their growth and their risk, and one on how it will pay for that growth. If you can't fill in a line, you don't have a valuation yet.
Yes. Knotd has the key ideas from Investment Valuation in a few minutes, in plain words, plus a Hot Take round and a Spot the Trap case to test them. It's one of 250+ non-fiction books in the app.
