Finance
by Aswath Damodaran
What is a business worth?
Aswath Damodaran teaches valuation at New York University, and he wrote this short book for investors who'd rather work out a company's value themselves than take an analyst's word for it. His claim is that any business can be valued, including a young one that has never made a profit.
Hear a sample · read by Laura
Intrinsic valuation works out what a business is worth from the cash it will produce. Relative valuation looks at what the market pays for similar companies, using multiples such as the price-earnings ratio. Damodaran notes that most valuations you see in practice are relative ones.
In an intrinsic valuation, value comes from the cash a business generates, how fast that cash grows and how risky it is. A famous brand or a star chief executive only adds value by changing one of those, for example by letting the company charge more.
Most valuations forecast a few years in detail, then capture everything after with a terminal value. Damodaran insists the growth rate you assume forever can't be higher than the economy's, and uses the risk-free rate as a ceiling. It matters, because the terminal value is often most of the total.
Damodaran follows companies through a life cycle, and each stage makes a different input hard to pin down. A young firm has no history to go on. A growth company has to keep its growth profitable. A mature one may be badly run, and a declining one may not survive.
Accountants treat a drug company's research spending as an ordinary expense, gone the year it's spent. Damodaran treats it as capital spending that builds an asset and pays off over years. Once you do, the company's profits and its return on capital can look very different.
What it's worth
A business is worth the cash it can make in the future, weighed by how risky that cash is.
Value or price
You can value a company on its own numbers or price it against similar ones. They answer different questions.
Bias
Every valuation carries the bias of whoever built it, so notice who paid for it.
Best guess
A valuation is a best guess and it will be wrong. That's no reason to skip it.
Simple models
Keep models simple. More detail rarely makes the answer more accurate.
Hot take · true or myth?
A bank can be valued the same way as a factory.
Myth. For a bank, debt is raw material, so it's hard to say what counts as debt or reinvestment. Damodaran values banks' equity directly, often from the dividends they pay.
One thing to try
Pick a company you follow. On one page, write how much cash it makes, how fast you think that will grow over five years, and what could go wrong. Then ask whether today's share price only makes sense if the growth never slows.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. The Little Book of 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 a business worth? Aswath Damodaran teaches valuation at New York University, and he wrote this short book for investors who'd rather work out a company's value themselves than take an analyst's word for it. His claim is that any business can be valued, including a young one that has never made a profit.
Two ways to value; Cash flow, growth and risk; Nothing outgrows the economy; Young, growing, grown-up, fading; Research is an investment.
Pick a company you follow. On one page, write how much cash it makes, how fast you think that will grow over five years, and what could go wrong. Then ask whether today's share price only makes sense if the growth never slows.
Yes. Knotd has the key ideas from The Little Book of 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.
