Last week, I got an opportunity to attend an event by Professor Aswath Damodaran. For those of you unfamiliar with him. Professor Damodaran is the Professor of Finance at Stern School of Business at New York University (NYU). He is one of the leading voices on the topic of financial valuation.
He is one of the key investors I follow regularly as I always find his method of valuing a company very refreshing. Therefore, when I heard he is coming to give a talk in Singapore, I jumped at the invitation.
The event: “An Evening With Professor Aswath Damodaran (Narratives & Numbers: The Value Of Stories In Business)” was organised by the CFA Society of Singapore and the Singapore alumni of NYU. Being a member of the CFA Society of Singapore, I was able to join the event at a sharply discounted price of just S$10, including dinner! Attending great events at highly discounted prices is just one of the many benefits for CFA members. And as a value investor, it is hard to resist a bargain when I see one.
So, there we are, packed into a hall of more than 300 people. Over the next 2 hours, Professor Damodaran discussed his process when it comes to valuing a company and showed real-life examples by valuing two very interesting companies; Uber Inc and Ferrari NV. Here are the key lessons I learned that evening.
Valuation Is A …….
First, Professor started asking us if we see valuation as an art or a science. At that point, I do know that valuation is neither an art or a science. After all, valuation is not a science because it is both subjective and dependent on the assumptions of the valuer heavily. Yet, it is not really an art as there are some rules and guidelines on how we should practice valuation.
However, his answer did surprise me. To him, valuation is a craft, just like how carpentry is a craft. Like all craft, we can get better at it if we put in the work and practice hard over time. We just need to get started and practice.
Every Valuation Is A Story
On top of that, I think many of us often see valuation as a series of calculation and numbers. However, Professor Damodaran saw things differently. He sees each valuation exercise as telling a story about a company. This means that even before he boots up his excel sheet to start his valuation exercise, he starts his process by understanding the business model & and thinking about the future of the company.
This is because, for every discount rate, growth rate, future operating margins and free cash flow we assumed for the future of the company is highlighting our expectation of the business going forward. Therefore, before we start to put in numbers into our valuation sheet, we should think deeply about how we see the company evolving into the future.
Getting our expectation and story about the company are the key fundamental building blocks of a good valuation. All too often, investors like to input numbers into a valuation exercise without thinking deeply enough about what all these numbers mean.
The Numbers And The Narrative Should Be Easily Translated
So, the narrative we created about the company should be translated into numbers in a valuation exercise. That is not all, the translation should work both ways. This means that when I read a sell-side report of a company, I should be able to translate the valuation in that report back into the story that the analyst is telling about the company. If as an investor, we fail to think about the relationship between the narrative and the numbers during a valuation, we might end up creating a valuation model that is unrealistic and unconvincing, even to ourselves.
The Valuation of Uber in 2014
Professor Damodaran put his theories together when he presented his valuation on Uber Inc. The ride-hailing company is now one of the highest priced startups in the world. However, the company is still a private company and many data regarding its financial are not public information. Moreover, the company is still loss-making and in a completely new industry. You can read his full post here.
However, that should not deter a seasoned practitioner from attempting to value the company. His valuation, done in 2014, show his thought process on how to go about creating a story for a business; even if it is just a new start-up.
He did his research on the company, by experiencing the service first hand and speaking with users and contractors of the company. Here is the story he created for the company at that time.
Notice how he first created the story on what he thought of the future of the company. He then translated that story into numbers and derived an estimation of the value of Uber Inc. His post on his valuation gathered a lot of interests from both the investing and technology crowd. And it led to him getting additional information about the company which he did not realized in the beginning. With the new information, he was then able to review and update his valuation on the company.
And that was the last lesson I have learned from him.
Valuation Is A Never-Ending Process
The point is that we should not stop our valuation exercise after we estimated a value for the company. That very first valuation would be as flawed as our first impression on the company. Valuation should be an on-going process. It is impossible for us to know all the information about a company before we start our valuation process. We have to work with the limited information that we have at that point in time.
However, we could and should review our valuation again and again once we have obtained new information about the company. In that way, we would be able to sharpen our craft in valuing a company and also keep up to date with the development of the companies we are interested in.
To learn more about valuation, you can visit Professor Aswath Damodaran Blog here.
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