INSIDE THE VALUATION PROCESS
1. Art or hard science: In the Middle
2. Three components of valuation process:
A. The bias that analysts bring to the process.
B. The uncertainty that they have to grapple with
C. The complexity that modern technology and easy access to information have introduced into
valuation.
Value First, Valuation to Follow: Bias in Valuation
Sources of Bias:
A. Companies we choose to value: we have perception before value.
B. We collect the information: financial statements (ex: annual report) use the best possible spin
on the numbers.
C. Access what other analysts following.
D. The market own estimate of the value of company: Marker Price (Valuation that stray too far
from this market price reflecting the large valuation errors rather that the market mistakes.
E. Institutional factors: Equity research analysts are more likely to issue buy rather than sell
recommendation, that is, they are more likely to find firms to be undervalued than overvalued.
F．Reward and punishment system: acquisition valuations are so often biased upward. 收购成功，分析师
挣钱；收购失败，分析师不挣钱
Manifestation of Bias:
A. Inputs: Optimistic or pessimistic assumption
B. Post-valuation tinkering: 事后估值修补
C. 区分估计的价值和考虑定性因素 Qualitative factor (synergy 协同效应, strategy)的价值的不同。(考虑定性因素，如战略因素是
为了估值让公司有高的收购价值，可用以下方法)
Premium(溢价): Control and synergy: Acquisition
Discounts (折扣): illiquidity and minority discounts: Tax and divorce court
What to Do about Bias: (Mitigate)
A. Reduce institutional pressures: Honest sell-side equity research.
B. Delink valuations from reward/punishment.
C. No precommitments.
D. Self-awareness: The best antidote to bias.
E. Honest reporting: (Bayesian Statistics): analysts are required to reveal their priors (biases)
before they present their results from an analysis.
It Is Only an Estimate: Imprecision and Uncertainty in Valuation
Sources of Uncertainty:
A. Estimation uncertainty: 从 raw information 到 inputs 再到 using in the mode,每一步都有 mistakes
B. Firm-specific uncertainty: Firms may do better or worse than we expected.
C. Macroeconomic uncertainty: Macroeconomic environment can change.
Responses of Uncertainty:
Healthy response:
A. Better valuation models: 模型使用更多可用信息，但是 real uncertainties with future 不可避免
B. Valuation ranges: Provide the best-case and worst-case estimates of value.
C. Probabilistic statements
Unhealthy response:
A． Passing the buck: 推卸责任：使用他人的数字，失败后指责他人。
B． Giving up on fundamentals: 用简单方式如 multiples and comparable.
对于不同公司的反应：Stable company 比 Growth company 好，mature company 比 young company 好，developed
company 比 emerging company 好。
What to Do about Uncertainty: (Analysts)
A. Using much information as they can legally access.
B. firm-specific components
C. be neutral as they can be on macroeconomic variables.
D. Warrants changes (dramatically)
Payoff to Valuation: 估值收益：一些分析师面对不确定性放弃，但有人不放弃。
Are Bigger Models Better? Valuation Complexity (Computer and information)
More Detail or Less Detail
Cost of Complexity: 使用复杂估值的成本
A． Information overload: 大量信息相矛盾
B． Black box syndrome: cannot understand the inner working of the box. They feed inputs into the
model’s black box and the box spits out a value.
C． Big versus small assumptions: Complex models always generate detailed output and 很难从小
Assumption 中分离出大 Assumption.
The Principle of Parsimony (简约): 在对资产估值时使用最简单的模型。不能使用一体化模型，因为他们都被设定可以用于最复杂的公司进行估值
APPROACHES TO VALUATION
Discount Cash Flow Valuation: the value of an asset is the present value of expected future cash flows on
that asset.
Relative Valuation: estimates the value of an asset by looking at the pricing of comparable assets relative
to a common variable like earnings, cash flows, book value, or sales.
Contingent Claim Valuation: uses option pricing models to measure the value of assets that share option
characteristic.
Discount Cash Flow Valuation
Basis for Approach:
A. Formula:
B. An action of faith:
Intrinsic Value: Estimate an asset by an all-knowing analyst with access to all information
available right now and a perfect valuation model.
We try to estimate the intrinsic value by using DCF but there is no way to know the true
intrinsic value, so here is no way to of knowing whether our DCF valuations are close to the
mark.
Classifying DCF Models (3 ways):
A． Business as a going concern as opposed to a collection of assets.
Going concern:
Value of business is different from value of sum of individual asset.
Business and company are an ongoing entity with assets that it already owns and assets it
expected to invest in the future.
For companies with lucrative growth opportunities, asset-based valuations will yield lower
values than going concern valuations.
A collection of assets (Asset-based valuation):
We focus primarily on the assets in place and estimate the value of each asset separately.
Adding the asset values together yields the value of the business.
liquidation valuation (for 1 asset): we value assets based on the presumption that they
must be sold now. In theory, this should be equal to the value obtained from DCF
valuations of individual assets, but the urgency associated with liquidating assets quickly
may result in a discount on the value.
B． Valuing the equity in a business and valuing the business itself.
Firm Valuation:
Both asset in place and growth asset.
All source of capital: Debt and Equity.
The cash flows before debt payments and after reinvestment needs are called free cash
flows to the firm, and the discount rate that reflects the composite cost of financing from
all sources of capital is called the cost of capital.
Equity Valuation:
Just value the equity stake in business. (The amount of ownership of a company owned by
a person, organization, or group of owners.)
Equity is Capital Invested by Owners in the Company, whereas Shares are the division of Capital or
Equity.
Equity = Asset – Liabilities = Shareholder’s equity + Reserves and Surplus
Shares = (Asset – Liabilities – Reserves and Surplus) * Price per share = Shareholder’s Equity
A stock is the actual asset in which you invest, while a share is the unit of measurement for that asset.
So, a stock tells you what you are investing in, and a share tells you how much of that stock you own.
2 types of methods: it is valued directly (by discounting cash flows to equity at the cost of
equity) or indirectly (by valuing the firm and subtracting out the value of all nonequity
claims).
Cash flow to equity: After debt and investment
C． Two different and equivalent ways of doing DCF valuation in addition to the expected cash flow
approach—a value based on excess returns and the adjusted present value (APV).
Excess returns Valuation:
将 cash flow 分为 Normal Cash flow (Risk adjustable require return)和 Excess Cash Flow (Above
or below, positive or negative).
用 excess return 来调节 Valuation
Adjusted present value (APV)
Debt increase, tax benefit increase, bankrupt risk increase.
用 tax 和 bankrupt 来调节 Valuation
Inputs to Discounted Cash Flow Models:
