Welcome to my study group for the equity valuation class being given by Professor Aswath Damodaran at NYU Stern this spring. I’m sorry about the delay in getting this started, but I got real busy with some last minute tax filing details. I’ve gotten a great response for this study group on stock valuation, so I’m excited to finally get started now.
First, I recommend that you start by watching the introduction to Equity Instruments. You will need to install the free Real Player to watch this class video. There will be a webcast for each of the 26 class sessions. For this first class, you will also want to pick up the three handouts, the syllabus, the project description, and the intro class presentation slides.
There are also 3 books on valuation by Damodaran that are recommended:
- Damodaran on Valuation – newest
- Investment Valuation – most comprehensive
- The Dark Side of Valuation
In this first lecture, Professor Damodaran gives the background history about this class, misleadingly called Equity Instruments and Markets. Even though the class is called Equity Instruments and Markets, it is really a valuation class. This is the old Ben Graham Security Analysis class, except Professor Damodaran has lopped off most of the material on bonds.
I recommend you skip to minute 14 in this first webcast to get past the housekeeping stuff for this course. You could even consider skipping the whole first hour if you are tight on time.
Course inspiration: “Everything is a valuation problem ultimately.”
“Every asset has a value; we just don’t know what it is,” states Professor Damodaran as the basic theme of this course. I’m excited about this class because, we are really going to get into the details of valuing businesses and then the common stock of those businesses.
Damodaran is going to cover 3 approaches to valuation over the semester:
- Intrinsic value – discounted cash flow models and beyond
- Relative valuation models – compared to other companies. What people are “willing to pay”
- Contingent claim valution – option valuation for valuing businesses
The classes will start by looking at the differences in valuation approaches, the advantage and disadvantages of the different approaches, and why you might use the different approaches depending on the situation. After briefly covering those issues, there will be 6 sessions grinding through the details of valution. These session will cover the basics of corporate finance. After getting the mechanics down, there will be 3 sessions on actually valuing companies. After we make it to this point, Damodaran states that we should then be able to value a company every ten minutes. That sounds pretty impressive to me.
The course then moves to relative valution after the 11th session. Most valuations we read about are relative valuations. I’m not a big fan of relative valuations but I’m curious to hear what the professor has to say about how to use relative valuation the right way. The relative valuation sessions will start with PE and move all the way to enterprise value ratios, such as the enterprise value to revenue ratio. I’m most interested in learning how to avoid the obvious traps Professor Damodaran knows about.
The course then covers valuing private businesses. The key issue with private company valuation appears to hinge on estimating cash flows when financials might be full of holes.
Then the class will cover the topic of using the option pricing model to value businesses. Damodaran will provide specific cases when the options model is useful and when it is not. As a value investor, I’m not sure I’ll be using the options pricing model very often but it might serve as a useful mental model.
Finally, the course will cover acquisition valuation and valuation enhancement. The professor made some interesting comments on the 20% control premium rule of thumb in M&A. It is apparently based on the averge premium paid over the market price over all transactions. The data comes from MergerStat. Damodaran speculates, however, that this premium could just be stupidity, ego, etc.
There is a project associated with this class that I would like us to also do. The project involves valuing companies as a group and applying all the valuation techniques on a real company. We should have each member of the study group take a company. The professor suggests that we include at least one money loosing company, one high revenue growth company, one non-US company, and one service company.
“There is no such thing as certainty,” states Professor Damodaran when it comes to valuations. Most people don’t believe in valuation according to Damodaran. He explains that he does valuation to fight the lemming effect. “They must know something I don’t know” are the seven deadliest words in valuation according to Damodaran. There is a lemming inside of each of us trying to get out and they can be lumped into three groups:
- Proud lemmings – Momentum investor
- Yogi bear lemmings – They think they are smarter than the average bear. They go to the edge and then think they can pull away.
- Lemmings with a life vest – valuation slows the process down, so we have something else holding us besides hope.
Perception effects price, but fundamentals determine value. I totally agree with that.
There are some misconceptions about valuations. Valuations are not objective or scientific. Valutions are more of an art. We should realize that they are biased. Valuations will also be effected by who is paying you for the valuation.
I got a kick out of Damodaran’s comment on the illusion of extra decimal points. I try to avoid looking at pennies and cents with all the uncertainty involved in valuing companies. But as Damodaran points out, adding those stray decimal points can make you look smart at work.
The other word of wisdom shared by Professor Damodaran is that meeting the management of a company will introduce bias that will really effect your valuation. He thinks it’s best to know nothing about a company to avoid biases. However, I’m not sure this is true for individuals that are really good at reading people. Regardless, I’m not one of those individuals gifted with the ability to judge people accurately based on a face to face meeting.
That’s it for the first lecture. I’ll be sending out an email to everyone who showed interest in joining a study group to let them know that we have started. We can use the comments section below this post to discuss this class session. Let us know what company you might want to research for the class valuation project.
I plan on completing another class session this week. After that, we can meet every Tuesday night here to discuss the next class. Time to hit the books.