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Dark Side of Valuation, The: Valuing Young, Distressed, and Complex Businesses, Third edition

Book Description

The Definitive Guide to Valuing Hard-to-Value Companies: Fully Revised for Today’s Financial Markets

Valuing money-making companies that have long histories and established business models is straightforward. It is when you encounter difficult-to-value companies that you feel the urge to go over to the dark side of valuation—where you abandon first principles and create new metrics. Aswath Damodaran looks at a range of these companies, from start-ups in new businesses to distressed companies, from banks facing regulatory turmoil to commodity firms, and from emerging market upstarts to multinationals that spread across geographies and businesses. With each grouping, he helps you examine the call of the dark side and its practices and frameworks to value these firms.

To answer these questions, Aswath looks at companies across the life cycle and in different markets, from Uber and Shake Shack at one end of the spectrum to Vale, Royal Dutch, and United Technologies at the other end.

In the process, you learn how to

  • Deal with “abnormally low” and negative risk-free rates in valuation
  • Adapt to dynamic and changing risk premiums
  • Value young companies that are disrupting existing businesses
  • Analyze commodity and cyclical companies across cycles
  • Value a company as the sum of its parts or as an aggregation of its users/subscribers and customers
  • Determine the difference between pricing and valuation, and why some investments can only be priced

Table of Contents

  1. Cover Page
  2. Title Page
  3. Copyright Page
  4. Dedication Page
  5. Contents at a Glance
  6. Contents
  7. Acknowledgments
  8. About the Author
  9. Preface to the Third Edition
  10. 1. The Dark Side of Valuation
    1. Foundations of Value
      1. Intrinsic Valuation
      2. Determinants of Value
    2. Valuation Across Time
      1. Interest Rates
      2. Market Risk Premiums
      3. The Macro Environment
    3. Valuation Across the Life Cycle
      1. The Business Life Cycle
      2. Early in the Life Cycle: Young Companies
      3. The Growth Phase: Growth Companies
      4. Maturity (A Mixed Blessing): Mature Firms
      5. Winding Down: Dealing with Decline
    4. Valuation Across the Business Spectrum
      1. Financial Services Firms
      2. Cyclical and Commodity Companies
      3. Businesses with Intangible Assets
      4. Emerging-Market Companies
      5. Multibusiness and Global Companies
      6. User-, Subscriber-, and Customer-Based Businesses
    5. The Dark Side of Valuation Beckons
      1. Input Phase
      2. Valuation Phase
      3. Post-Valuation Phase
    6. Conclusion
  11. Part I: Enlightenment: The Tools
    1. 2. Intrinsic Valuation
      1. Discounted Cash Flow Valuation
        1. The Essence of DCF Valuation
        2. Equity Versus Firm Valuation
        3. Inputs to a DCF Valuation
      2. Variations on DCF Valuation
        1. Certainty-Adjusted Cash Flow Models
        2. Adjusted Present-Value Models
        3. Excess-Return Models
      3. What Do Intrinsic Valuation Models Tell Us?
      4. Conclusion
    2. 3. Probabilistic Valuation: Scenario Analysis, Decision Trees, and Simulations
      1. Scenario Analysis
        1. Best Case/Worst Case
        2. Multiple Scenario Analysis
      2. Decision Trees
        1. Steps in Decision Tree Analysis
        2. Estimation Issues
        3. Risk-Adjusted Value and Decision Trees
      3. Simulations
        1. Steps in Simulation
        2. Use in Decision Making
        3. Simulations with Constraints
        4. Issues with Using Simulations
        5. Risk-Adjusted Value and Simulations
      4. An Overall View of Probabilistic Risk Assessment Approaches
        1. Comparing the Approaches
        2. A Complement to or Replacement for Risk-Adjusted Value
      5. Conclusion
    3. 4. Relative Valuation/Pricing
      1. What Is Relative Valuation?
      2. The Ubiquity of Relative Valuation
      3. Reasons for Popularity and Potential Pitfalls
      4. Standardized Values and Multiples
        1. Earnings Multiples
        2. Book Value or Replacement Value Multiples
        3. Revenue Multiples
        4. Sector-Specific Multiples
      5. The Four Basic Steps of Using Multiples
        1. Definitional Tests
        2. Descriptive Tests
        3. Analytical Tests
        4. Application Tests
      6. Reconciling Relative and Intrinsic Valuations
      7. Conclusion
    4. 5. Real Options Valuation
      1. The Essence of Real Options
      2. Real Options, Risk-Adjusted Value, and Probabilistic Assessments
      3. Real Options Examples
        1. The Option to Delay an Investment
        2. The Option to Expand an Investment
        3. The Option to Abandon an Investment
      4. Caveats for Real Options
      5. Conclusion
      6. Appendix: Basics of Options and Option Pricing
        1. Option Payoffs
        2. Determinants of Option Value
        3. Option Pricing Models
  12. Part II: The Dark Side of Macro Inputs
    1. 6. A Shaky Base: A “Risky” Risk-Free Rate
      1. What Is a Risk-Free Asset?
      2. Why Do Risk-Free Rates Matter?
      3. Estimating a Risk-Free Rate
        1. Requirements for an Investment to Be Risk-Free
        2. The Purist Solution
        3. A Practical Compromise
        4. The Currency Effect
        5. Real Versus Nominal Risk-Free Rates
      4. Issues in Estimating Risk-Free Rates
        1. There Are No Long-Term Traded Government Bonds
        2. The Government Is Not Default-Free
        3. The Risk-Free Rate Might Change Over Time
      5. Closing Thoughts on Risk-Free Rates
      6. Conclusion
      7. Appendix 6.1
    2. 7. Risky Ventures: Assessing the Price of Risk
      1. Why Do Risk Premiums Matter?
      2. What Are the Determinants of Risk Premiums?
        1. Equity Risk Premiums
        2. Default Spreads
      3. Standard Approaches for Estimating Risk Premiums
        1. Equity Risk Premiums
        2. Default Spreads
        3. Problem Scenarios
        4. The Dark Side
        5. The Light Side
        6. The Dark Side
        7. The Light Side
        8. The Dark Side
        9. The Light Side
      4. Conclusion
      5. Appendix 7.1
    3. 8. Macro Matters: The Real Economy
      1. Growth in the Real Economy
        1. Why Does Real Economic Growth Matter?
        2. Looking at History
        3. The Dark Side
        4. The Light Side
      2. Expected Inflation
        1. Why Does Expected Inflation Matter?
        2. Looking at History
        3. U.S. Inflation Rate Across Time
        4. The Dark Side
        5. The Light Side
      3. Exchange Rates
        1. Why Do Exchange Rates Matter?
        2. Looking at History
        3. The Dark Side
        4. The Light Side
      4. Conclusion
  13. Part III: The Dark Side across the Life Cycle
    1. 9. Baby Steps: Young and Start-Up Companies
      1. Young Companies in the Economy
        1. A Life Cycle View of Young Companies
        2. Characteristics of Young Companies
      2. Valuation Issues
        1. Intrinsic (DCF) Valuation
        2. Relative Valuation
      3. The Dark Side
      4. The Light Side
        1. Discounted Cash Flow Valuation
        2. Relative Valuation
        3. Real Options
      5. Conclusion
    2. 10. Shooting Stars: Valuing Growth Companies
      1. Growth Companies
        1. A Life Cycle View of Growth Companies
      2. Characteristics of Growth Companies
      3. Valuation Issues
        1. Intrinsic Value
      4. The Dark Side of Valuation
        1. Discounted Cash Flow Valuation
        2. Relative Valuation
      5. The Light Side of Valuation
        1. Discounted Cash Flow Valuation
        2. Relative Valuation
      6. Conclusion
    3. 11. The Grown-Ups: Mature Companies
      1. Mature Companies in the Economy
        1. A Life Cycle View of Mature Companies
        2. Characteristics of Mature Companies
      2. Valuation Issues
        1. Intrinsic (DCF) Valuation
        2. Relative Valuation
      3. The Dark Side of Valuation
        1. Growth in Mature Companies
        2. Acquisition Inconsistencies
        3. Unreal Restructuring
        4. Debt and Value
      4. Relative Valuation
      5. The Light Side of Valuation
        1. Growth and Acquisitions
        2. Changing Management
        3. The Expected Value of Control
      6. Conclusion
    4. 12. Winding Down: Declining Companies
      1. Declining Companies in the Economy
        1. A Life Cycle View of Declining Companies
        2. Characteristics of Declining Companies
      2. Valuation Issues
        1. Intrinsic (DCF) Valuation
        2. From Operating Assets to Equity Value per Share
        3. Relative Valuation
      3. The Dark Side of Valuation
        1. Autopilot Optimism
        2. Discount Rate Contortions
        3. Divestiture Follies
        4. Book Capital
        5. Dealing with Distress
        6. Relative Valuation
      4. The Light Side of Valuation
        1. A Framework for Dealing with Decline and Distress
        2. Irreversible Decline, Low Distress
        3. Reversible Decline, Low Distress
        4. Distress
      5. Conclusion
  14. Part IV: The Dark Side Across Company Types
    1. 13. Ups and Downs: Cyclical and Commodity Companies
      1. The Setting
        1. Cyclical Companies
        2. Commodity Companies
        3. Characteristics
      2. The Dark Side of Valuation
        1. Base Year Fixation
        2. The Macro Crystal Ball
        3. Macro Point of View (POV) Valuations
        4. Selective Normalization
        5. False Stability
      3. The Light Side of Valuation
        1. Discounted Cash Flow Valuation
        2. Relative Valuation
        3. The Real Options Argument for Undeveloped Reserves
      4. Conclusion
    2. 14. Mark to Market: Valuing Financial Services Companies
      1. Financial Services Firms: The Big Picture
      2. Characteristics of Financial Services Firms
        1. The Regulatory Overlay
        2. Differences in Accounting Rules
        3. Debt and Equity
        4. Estimating Cash Flows Is Difficult
      3. The Dark Side of Valuation
        1. Debt
        2. Cash Flow Substitutes
        3. Go with the Flow: Dividends
        4. Trusting Book Value
        5. Regulation and Risk
        6. The Light Side of Valuation
        7. Discounted Cash Flow Models
        8. Asset-Based Valuation
        9. Relative Valuation
      4. Conclusion
    3. 15. Invisible Investments: Valuing Firms with Intangible Assets
      1. Firms with Intangible Assets
        1. Intangible Assets in the Overall Economy
        2. Characteristics of Firms with Intangible Assets
        3. Valuation Consequences
      2. The Dark Side of Valuation
        1. Intrinsic Valuation
        2. Relative Valuation
      3. The Light Side of Valuation
        1. Regaining Accounting Consistency
        2. Dealing with Equity Options
        3. Debt and Cash
        4. The Compressed Life Cycle
      4. Conclusion
    4. 16. Volatility Rules: Emerging-Market Companies
      1. The Role of Emerging-Market Companies
        1. Emerging-Market Companies in the Global Economy
        2. Why Do Emerging Economies Matter?
        3. Characteristics of Emerging-Market Companies
      2. The Dark Side of Valuation
        1. Currency Mismatches
        2. Miscounting and Double-Counting Country Risk
        3. Risk Parameters
        4. Incorporation Effect
        5. Ignoring Missing Information
        6. Corporate Governance Mood Swings
        7. Post-Valuation Discounts
      3. The Light Side of Valuation
        1. Discounted Cash Flow Valuation
        2. Relative Valuation
      4. Conclusion
    5. 17. Going to Pieces: Disaggregated Value
      1. Aggregation versus Disaggregation
      2. Multinational Conglomerates
        1. Role in the Economy
        2. Characteristics
        3. Valuation Issues
      3. The Dark Side of Valuation
        1. Intrinsic Valuation
        2. Relative Valuation
      4. The Light Side of Valuation
        1. Discounted Cash Flow Valuation
        2. Relative Valuation
      5. User/Subscriber/Customer Companies
        1. The Rise of the User
        2. Valuation Issues
        3. The Dark Side of Valuation
        4. The Light Side of Valuation
      6. Conclusion
    6. 18. The Cynic’s Corner: Value versus Price
      1. Value versus Price
      2. Investing versus Trading
        1. The Value Game versus the Pricing Game
        2. Investing versus Trading
        3. The Dark Side
        4. The Light Side
      3. The Right Approach
        1. Job Description
        2. Cui Bono?
        3. How Are You Judged?
        4. The Dark Side
        5. The Light Side
      4. Categorizing Investments
        1. Cash Flow–Generating Assets
        2. Commodities
        3. Currencies
        4. Collectibles
      5. The Questionable Investments
        1. Gold (and Other Precious Metals)
        2. Crypto Investments
        3. Trophy Assets
      6. Conclusion
  15. Part V: The Finale
    1. 19. The Jedi Way: Vanquishing the Dark Side
      1. Enlightening Propositions
        1. Proposition 1: Be Steadfast on Principles, Open to New Tools, and Flexible on Estimates
        2. Proposition 2: Pay Heed to Markets, but Don’t Let Them Determine Your Valuations
        3. Proposition 3: Risk Matters
        4. Proposition 4: Growth Is Not Free and Is Not Always Value-Adding
        5. Proposition 5: All Good Things Come to an End
        6. Proposition 6: Watch Out for Truncation Risk
        7. Proposition 7: Look at the Past, but Think About the Future
        8. Proposition 8: Draw on the Law of Large Numbers
        9. Proposition 9: Accept Uncertainty, and Deal with It
        10. Proposition 10: Value = Stories + Numbers
      2. Conclusion
  16. Index