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Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, Third Edition

Book Description

The definitive source of information on all topics related to investment valuation tools and techniques

Valuation is at the heart of any investment decision, whether that decision is buy, sell or hold. But the pricing of many assets has become a more complex task in modern markets, especially after the recent financial crisis. In order to be successful at this endeavor, you must have a firm understanding of the proper valuation techniques. One valuation book stands out as withstanding the test of time among investors and students of financial markets, Aswath Damodaran'sInvestment Valuation.

Now completely revised and updated to reflect changing market conditions, this third edition comprehensively introduces investment professionals and students to the range of valuation models available and how to chose the right model for any given asset valuation scenario. This edition includes valuation techniques for a whole host of real options, start-up firms, unconventional assets, distressed companies and private equity, and real estate. All examples have been updated and new material has been added.

  • Fully revised to incorporate valuation lessons learned from the last five years, from the market crisis and emerging markets to new types of equity investments

  • Includes valuation practices across the life cycle of companies and emphasizes value enhancement measures, such as EVA and CFROI

  • Contains a new chapter on probabilistic valuation techniques such as decision trees and Monte Carlo Simulation

  • Author Aswath Damodaran is regarded as one of the best educators and thinkers on the topic of investment valuation

This indispensable guide is a must read for anyone wishing to gain a better understanding of investment valuation and its methods. With it, you can take the insights and advice of a recognized authority on the valuation process and immediately put them to work for you.

Table of Contents

  1. Cover Page
  2. Website
  3. Title Page
  4. Copyright
  5. Dedication
  6. Preface to the Third Edition
  7. Contents
  8. CHAPTER 1: Introduction to Valuation
    1. A PHILOSOPHICAL BASIS FOR VALUATION
    2. GENERALITIES ABOUT VALUATION
    3. THE ROLE OF VALUATION
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  9. CHAPTER 2: Approaches to Valuation
    1. DISCOUNTED CASH FLOW VALUATION
    2. RELATIVE VALUATION
    3. CONTINGENT CLAIM VALUATION
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  10. CHAPTER 3: Understanding Financial Statements
    1. THE BASIC ACCOUNTING STATEMENTS
    2. ASSET MEASUREMENT AND VALUATION
    3. MEASURING FINANCING MIX
    4. MEASURING EARNINGS AND PROFITABILITY
    5. MEASURING RISK
    6. OTHER ISSUES IN ANALYZING FINANCIAL STATEMENTS
    7. CONCLUSION
    8. QUESTIONS AND SHORT PROBLEMS
  11. CHAPTER 4: The Basics of Risk
    1. WHAT IS RISK?
    2. EQUITY RISK AND EXPECTED RETURN
    3. ALTERNATIVE MODELS FOR EQUITY RISK
    4. A COMPARATIVE ANALYSIS OF EQUITY RISK MODELS
    5. MODELS OF DEFAULT RISK
    6. CONCLUSION
    7. QUESTIONS AND SHORT PROBLEMS
  12. CHAPTER 5: Option Pricing Theory and Models
    1. BASICS OF OPTION PRICING
    2. DETERMINANTS OF OPTION VALUE
    3. OPTION PRICING MODELS
    4. EXTENSIONS OF OPTION PRICING
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  13. CHAPTER 6: Market Efficiency—Definition, Tests, and Evidence
    1. MARKET EFFICIENCY AND INVESTMENT VALUATION
    2. WHAT IS AN EFFICIENT MARKET?
    3. IMPLICATIONS OF MARKET EFFICIENCY
    4. NECESSARY CONDITIONS FOR MARKET EFFICIENCY
    5. PROPOSITIONS ABOUT MARKET EFFICIENCY
    6. TESTING MARKET EFFICIENCY
    7. CARDINAL SINS IN TESTING MARKET EFFICIENCY
    8. SOME LESSER SINS THAT CAN BE A PROBLEM
    9. EVIDENCE ON MARKET EFFICIENCY
    10. TIME SERIES PROPERTIES OF PRICE CHANGES
    11. MARKET REACTION TO INFORMATION EVENTS
    12. MARKET ANOMALIES
    13. EVIDENCE ON INSIDERS AND INVESTMENT PROFESSIONALS
    14. CONCLUSION
    15. QUESTIONS AND SHORT PROBLEMS
  14. CHAPTER 7: Riskless Rates and Risk Premiums
    1. THE RISK-FREE RATE
    2. EQUITY RISK PREMIUM
    3. DEFAULT SPREADS ON BONDS
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  15. CHAPTER 8: Estimating Risk Parameters and Costs of Financing
    1. THE COST OF EQUITY AND CAPITAL
    2. COST OF EQUITY
    3. FROM COST OF EQUITY TO COST OF CAPITAL
    4. BEST PRACTICES AT FIRMS
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  16. CHAPTER 9: Measuring Earnings
    1. ACCOUNTING VERSUS FINANCIAL BALANCE SHEETS
    2. ADJUSTING EARNINGS
    3. CONCLUSION
    4. QUESTIONS AND SHORT PROBLEMS
  17. CHAPTER 10: From Earnings to Cash Flows
    1. THE TAX EFFECT
    2. REINVESTMENT NEEDS
    3. CONCLUSION
    4. QUESTIONS AND SHORT PROBLEMS
  18. CHAPTER 11: Estimating Growth
    1. THE IMPORTANCE OF GROWTH
    2. HISTORICAL GROWTH
    3. ANALYST ESTIMATES OF GROWTH
    4. FUNDAMENTAL DETERMINANTS OF GROWTH
    5. QUALITATIVE ASPECTS OF GROWTH
    6. CONCLUSION
    7. QUESTIONS AND SHORT PROBLEMS
  19. CHAPTER 12: Closure in Valuation: Estimating Terminal Value
    1. CLOSURE IN VALUATION
    2. THE SURVIVAL ISSUE
    3. CLOSING THOUGHTS ON TERMINAL VALUE
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  20. CHAPTER 13: Dividend Discount Models
    1. THE GENERAL MODEL
    2. VERSIONS OF THE MODEL
    3. ISSUES IN USING THE DIVIDEND DISCOUNT MODEL
    4. TESTS OF THE DIVIDEND DISCOUNT MODEL
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  21. CHAPTER 14: Free Cash Flow to Equity Discount Models
    1. MEASURING WHAT FIRMS CAN RETURN TO THEIR STOCKHOLDERS
    2. FCFE VALUATION MODELS
    3. FCFE VALUATION VERSUS DIVIDEND DISCOUNT MODEL VALUATION
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  22. CHAPTER 15: Firm Valuation: Cost of Capital and Adjusted Present Value Approaches
    1. FREE CASH FLOW TO THE FIRM
    2. FIRM VALUATION: THE COST OF CAPITAL APPROACH
    3. FIRM VALUATION: THE ADJUSTED PRESENT VALUE APPROACH
    4. EFFECT OF LEVERAGE ON FIRM VALUE
    5. Cost of Capital and Optimal Leverage
    6. ADJUSTED PRESENT VALUE AND FINANCIAL LEVERAGE
    7. CONCLUSION
    8. QUESTIONS AND SHORT PROBLEMS
  23. CHAPTER 16: Estimating Equity Value per Share
    1. VALUE OF NONOPERATING ASSETS
    2. FIRM VALUE AND EQUITY VALUE
    3. MANAGEMENT AND EMPLOYEE OPTIONS
    4. VALUE PER SHARE WHEN VOTING RIGHTS VARY
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  24. CHAPTER 17: Fundamental Principles of Relative Valuation
    1. USE OF RELATIVE VALUATION
    2. STANDARDIZED VALUES AND MULTIPLES
    3. FOUR BASIC STEPS TO USING MULTIPLES
    4. RECONCILING RELATIVE AND DISCOUNTED CASH FLOW VALUATIONS
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  25. CHAPTER 18: Earnings Multiples
    1. PRICE-EARNINGS RATIO
    2. THE PEG RATIO
    3. OTHER VARIANTS ON THE PE RATIO
    4. ENTERPRISE VALUE TO EBITDA MULTIPLE
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  26. CHAPTER 19: Book Value Multiples
    1. PRICE-TO-BOOK EQUITY
    2. APPLICATIONS OF PRICE–BOOK VALUE RATIOS
    3. USE IN INVESTMENT STRATEGIES
    4. VALUE-TO-BOOK RATIOS
    5. TOBIN'S Q: MARKET VALUE/REPLACEMENT COST
    6. CONCLUSION
    7. QUESTIONS AND SHORT PROBLEMS
  27. CHAPTER 20: Revenue Multiples and Sector-Specific Multiples
    1. REVENUE MULTIPLES
    2. SECTOR-SPECIFIC MULTIPLES
    3. CONCLUSION
    4. QUESTIONS AND SHORT PROBLEMS
  28. CHAPTER 21: Valuing Financial Service Firms
    1. CATEGORIES OF FINANCIAL SERVICE FIRMS
    2. WHAT IS UNIQUE ABOUT FINANCIAL SERVICE FIRMS?
    3. GENERAL FRAMEWORK FOR VALUATION
    4. DISCOUNTED CASH FLOW VALUATION
    5. ASSET-BASED VALUATION
    6. RELATIVE VALUATION
    7. ISSUES IN VALUING FINANCIAL SERVICE FIRMS
    8. CONCLUSION
    9. QUESTIONS AND SHORT PROBLEMS
  29. CHAPTER 22: Valuing Firms with Negative or Abnormal Earnings
    1. NEGATIVE EARNINGS: CONSEQUENCES AND CAUSES
    2. VALUING NEGATIVE EARNINGS FIRMS
    3. CONCLUSION
    4. QUESTIONS AND SHORT PROBLEMS
  30. CHAPTER 23: Valuing Young or Start-Up Firms
    1. INFORMATION CONSTRAINTS
    2. NEW PARADIGMS OR OLD PRINCIPLES: A LIFE CYCLE PERSPECTIVE
    3. VENTURE CAPITAL VALUATION
    4. GENERAL FRAMEWORK FOR ANALYSIS
    5. VALUE DRIVERS
    6. ESTIMATION NOISE
    7. IMPLICATIONS FOR INVESTORS
    8. IMPLICATIONS FOR MANAGERS
    9. THE EXPECTATIONS GAME
    10. CONCLUSION
    11. QUESTIONS AND SHORT PROBLEMS
  31. CHAPTER 24: Valuing Private Firms
    1. WHAT MAKES PRIVATE FIRMS DIFFERENT?
    2. ESTIMATING VALUATION INPUTS AT PRIVATE FIRMS
    3. VALUATION MOTIVES AND VALUE ESTIMATES
    4. VALUING VENTURE CAPITAL AND PRIVATE EQUITY STAKES
    5. RELATIVE VALUATION OF PRIVATE BUSINESSES
    6. CONCLUSION
    7. QUESTIONS AND SHORT PROBLEMS
  32. CHAPTER 25: Aquisitions and Takeovers
    1. BACKGROUND ON ACQUISITIONS
    2. EMPIRICAL EVIDENCE ON THE VALUE EFFECTS OF TAKEOVERS
    3. STEPS IN AN ACQUISITION
    4. TAKEOVER VALUATION: BIASES AND COMMON ERRORS
    5. STRUCTURING THE ACQUISITION
    6. ANALYZING MANAGEMENT AND LEVERAGED BUYOUTS
    7. CONCLUSION
    8. QUESTIONS AND SHORT PROBLEMS
  33. CHAPTER 26: Valuing Real Estate
    1. REAL VERSUS FINANCIAL ASSETS
    2. DISCOUNTED CASH FLOW VALUATION
    3. COMPARABLE/RELATIVE VALUATION
    4. VALUING REAL ESTATE BUSINESSES
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  34. CHAPTER 27: Valuing Other Assets
    1. CASH-FLOW-PRODUCING ASSETS
    2. NON-CASH-FLOW-PRODUCING ASSETS
    3. ASSETS WITH OPTION CHARACTERISTICS
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  35. CHAPTER 28: The Option to Delay and Valuation Implications
    1. THE OPTION TO DELAY A PROJECT
    2. VALUING A PATENT
    3. NATURAL RESOURCE OPTIONS
    4. OTHER APPLICATIONS
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  36. CHAPTER 29: The Options to Expand and to Abandon: Valuation Implications
    1. THE OPTION TO EXPAND
    2. WHEN ARE EXPANSION OPTIONS VALUABLE?
    3. VALUING A FIRM WITH THE OPTION TO EXPAND
    4. VALUE OF FINANCIAL FLEXIBILITY
    5. THE OPTION TO ABANDON
    6. RECONCILING NET PRESENT VALUE AND REAL OPTION VALUATIONS
    7. CONCLUSION
    8. QUESTIONS AND SHORT PROBLEMS
  37. CHAPTER 30: Valuing Equity in Distressed Firms
    1. EQUITY IN HIGHLY LEVERED DISTRESSED FIRMS
    2. IMPLICATIONS OF VIEWING EQUITY AS AN OPTION
    3. ESTIMATING THE VALUE OF EQUITY AS AN OPTION
    4. CONSEQUENCES FOR DECISION MAKING
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  38. CHAPTER 31: Value Enhancement: A Discounted Cash Flow Valuation Framework
    1. VALUE-CREATING AND VALUE-NEUTRAL ACTIONS
    2. WAYS OF INCREASING VALUE
    3. VALUE ENHANCEMENT CHAIN
    4. CLOSING THOUGHTS ON VALUE ENHANCEMENT
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  39. CHAPTER 32: Value Enhancement: Economic Value Added, Cash Flow Return on Investment, and Other Tools
    1. ECONOMIC VALUE ADDED
    2. CASH FLOW RETURN ON INVESTMENT
    3. A POSTSCRIPT ON VALUE ENHANCEMENT
    4. CONCLUSION
    5. QUESTIONS AND SHORT PROBLEMS
  40. CHAPTER 33: Probabilistic Approaches in Valuation: Scenario Analysis, Decision Trees, and Simulations
    1. SCENARIO ANALYSIS
    2. DECISION TREES
    3. SIMULATIONS
    4. AN OVERALL ASSESSMENT OF PROBABILISTIC RISK-ASSESSMENT APPROACHES
    5. CONCLUSION
    6. QUESTIONS AND SHORT PROBLEMS
  41. CHAPTER 34: Overview and Conclusion
    1. CHOICES IN VALUATION MODELS
    2. WHICH APPROACH SHOULD YOU USE?
    3. CHOOSING THE RIGHT DISCOUNTED CASH FLOW MODEL
    4. CHOOSING THE RIGHT RELATIVE VALUATION MODEL
    5. WHEN SHOULD YOU USE THE OPTION PRICING MODELS?
    6. CONCLUSION
  42. References
    1. Chapter 1 Introduction to Valuation
    2. Chapter 2 Approaches to Valuation
    3. Chapter 3 Understanding Financial Statements
    4. Chapter 4 The Basics of Risk
    5. Chapter 5 Option Pricing Theory and Models
    6. Chapter 6 Market Efficiency—Definitions, Tests, and Evidence
    7. Chapter 7 Riskless Rates and Risk Premiums
    8. Chapter 8 Estimating Risk Parameters and Costs of Financing
    9. Chapter 9 Measuring Earnings
    10. Chapter 10 From Earnings to Cash Flows
    11. Chapter 11 Estimating Growth
    12. Chapter 12 Closure in Valuation: Estimating Terminal Value
    13. Chapter 13 Dividend Discount Models
    14. Chapter 14 Free Cash Flow to Equity Discount Models
    15. Chapter 15 Firm Valuation: Cost of Capital and Adjusted Present Value Approaches
    16. Chapter 16 Estimating Equity Value per Share
    17. Chapter 17 Fundamental Principles of Relative Valuation
    18. Chapter 18 Earnings Multiples
    19. Chapter 19 Book Value Multiples
    20. Chapter 20 Revenue Multiples and Sector-Specific Multiples
    21. Chapter 21 Valuing Financial Service Firms
    22. Chapter 22 Valuing Firms with Negative Earnings
    23. Chapter 23 Valuing Young or Start-Up Firms
    24. Chapter 24 Valuing Private Firms
    25. Chapter 25 Acquisitions and Takeovers
    26. Chapter 26 Valuing Real Estate
    27. Chapter 27 Valuing Other Assets
    28. Chapter 28 The Option to Delay and Valuation Implications
    29. Chapter 29 The Options to Expand and to Abandon: Valuation Implications
    30. Chapter 30 Valuing Equity in Distressed Firms
    31. Chapter 31 Value Enhancement: A Discounted Cash Flow Valuation Framework
    32. Chapter 32 Value Enhancement: Economic Value Added, Cash Flow Return on Investment, and Other Tools
    33. Chapter 33 Probabilistic Approaches in Valuation
    34. Chapter 34 Overview and Conclusion
  43. Index