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Valuation 101: Cash Flows, Growth And Risk

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In this class, we looked at valuation as the place where all of the pieces of corporate finance come together – the end game for your investment, financing and dividend decisions. After drawing a contrast between valuation and pricing, we looked at the four drivers of value: cash flows, growth rates, discount rates and when your company will be a stable growth company. We then looked at how these numbers can be different depending on whether you take an equity or firm perspective to valuation and what causes these numbers to change. In particular, while no one can lay claim on the “right” value, we still need to be internally consistent with our assumptions. High growth generally will be accompanied by high reinvestment and high risk, and as companies mature, their growth and reinvestment characteristics should change. Ultimately, though, the best way to learn valuation is by playing with the numbers and seeing how value changes. I did talk about the presence of uncertainty and how it affects how you approach the numbers and if you are interested, you may find my blog post relevant for that discussion: http://aswathdamodaran.blogspot.com/

I also mentioned a valuation of Deutsche Bank. On the off chance that you want to dig deeper, here is my take on Deutsche in October 2016: http://aswathdamodaran.blogspot.com/

Finally, I did mention a spreadsheet that is versatile enough to cover every company in this class. Please use it for your valuation: http://www.stern.nyu.edu/~adamodar/pc… Many of the inputs that you need for this spreadsheet should have already have been estimated or looked up for other parts of the project. Also, as you enter the key numbers for revenue growth, target operating margin and sales/invested capital, think of the story that drives these numbers.

Slides: http://www.stern.nyu.edu/

Valuation 101: Cash Flows, Growth And Risk

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Thousand and seventeen final exams. My platform. So today we're going to talk about the icing on the cake. We've we dancer on this word all through the class. There's no way to avoid it anymore. But what's your objective in corporate finance again to maximize the value of the business. Right. So when you take projects what are you trying to do you're trying to take projects to increase your value as a company. That's why positive net present value projects are good. When you think about financing mix we find that mix of debt and equity that maximizes the value of the business. That's why we minimize the cost of capital. And again when we look at dividends a question we ask is if you have projects that you can take. Don't give the cash out as dividends because it'll affect your value. But we haven't really confronted this word value yet. So today I'd like to bring it all back to the question of value. And before I do that I want to draw a contrast between two words that people use interchangeably that they should not you can value something you can price something.

It is a fixation I have in my valuation class. But I kind of return to my fixation and I'd like to start with the Oscar Wilde quote on a cynic being somebody who knows the price of everything and the value of nothing. You can replace the word cynic with trader and you could pretty much have the same definition. Traders know the price of everything goes right down the Bloomberg in front of them. They don't have a sense of what the value is. And I wouldn't pick on traders most people when they talk about valuing something I really talk my pricings. So let's start by laying out where we're going. We're going to talk about the value of the business but we're going to do this from the inside out. In fact when I'm asked to contrast my two classes corporate finance and valuation I tell people I teach the same thing twice and the difference in the valuation class in the corporate finance class is not that the words I use a different but in valuation I look at companies from the outside it says an investor in the company said this is what the value the company given how it's run. But then I step away. I'm not running the company it's not my business I'm just going to buy it. So I think of companies badly managed and badly run I give you the value with it badly managed and badly wrong in corporate finance. We look at value from the inside out. What does that mean.

All the levers are under your control you can't complain if you're the manager of a company. It's a badly run company. You're the one running the company so when we think about corporate finance we're thinking about all the levers you have in valuation but now those levers are levers you can move. So when I talk about valuation in this class I'm going to connected back to everything we've talked about so far. How. Taking better projects affects value. How changing your mix of debt and equity affects value how altering your dividend policy might affect that. So let me lay out the three different ways in which you can put a number on an asset and use that as my contract for why I want to focus on value. When you're asked to put a number on a company a business and ask the first way to do it is to do it with intrinsic valuation value that for the asset based on its cash flows its growth its risk. So when we think about valuation this is what we tend to think about. And if we use a discounted cash flow model great it says one way in which you bring cash flows growth and risk but it's not the only way. So that's a first way to put a number on something. The second is pricing and pricing. You don't try to attach a number to an asset based on what's cash flow growth or risk. You attach a number to an asset based on what other people are paying for similar assets. So your focus is no longer what's the right number. It's what everybody else pay.

So I'll give you a very simple way to draw this contrast. This Thursday Uber is going to go public. We don't know what number yet. But on that opening day the deal but when the stock trades or is it going to be priced or valued it's going to be priced right now that price might be equal the value might not be but pricing is based on demand and supply. I think what's going to drive that demand and supply currently knows. It could change between now and Thursday in fact I'm sure every investment banker involved in that transaction is sitting there saying oh my god let these four days go by really fast because you can have the entire world shift under you in four days. And by the time the company hits the most the market this Thursday the mood could have shifted so dramatically that the pricing could be 40 billion not 90 billion or it could go in the other direction could be 130 billion. It's going to be priced. Can you valuable. Yes it's going to be difficult why because it's a young company with everything in its future but you still have cash flows growth and risk you're not going to walk away from those concepts just the fact that you kind of estimate them as easily doesn't mean you abandon them so intrinsic valuation you try to attach a value to an asset base based on its cash flow growth and risk you build up value from the inside out.

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