Session 25: Closing Thoughts

Introduction

The instructor introduces the topic of valuation and emphasizes the importance of establishing narratives in valuation.

Key Points

• Valuation is about establishing narratives.

• A good valuation should tell a story, not just focus on numbers.

Parting Thoughts

The instructor provides some parting thoughts for students to keep in mind when doing valuations.

Key Points

• Focus on the big picture.

• Have a healthy respect for luck.

• Learn valuation by doing, not just talking or reading about it.

Approaches to Valuation

The instructor discusses three approaches to valuation: discounted cash flow, relative valuation, and contingent claim valuation.

Key Points

• Discounted cash flow involves estimating cash flows and attaching a discount rate based on risk assessment.

• Relative valuation involves valuing an asset based on similar assets.

• Contingent claim valuation uses option pricing models to value certain types of businesses.

Discounted Cash Flow Valuation

The instructor reviews the key variables that drive discounted cash flow valuations.

Key Points

• Cash flows from existing investments are important.

• Future growth can come from efficiency or new investments.

• Discount rates should be attached to cash flows based on risk assessment.

• Liquidation value or terminal value can be used as closure in the model.

Relative Valuation

The instructor reviews the four-step process for deconstructing multiples in relative valuation.

Key Points

• Define the multiple and check for consistency.

• Make sure numerator and denominator are both equity values or enterprise values.

• Describe the multiple's distribution.

• Analyze what is under the hood of every multiple.

Driving Variables for Different Multiples

The instructor summarizes the driving variables for different multiples using a simple technique.

Key Points

• Use the stable growth dividend discount model to extract variables that drive price earnings ratio or price-to-book ratio.

• Use the stable growth free cash flow to the firm model to derive variables that drive enterprise value multiples.

• Keep your eyes on pricing of similar assets in relative valuation.

Real Options Models

The instructor discusses when real options models should be used in valuation.

Key Points

• Real options models should be used when there is exclusivity involved.

• Real options models can be used to value patents, natural resource options, strategic investments, and flexibility.

Conclusion

Valuation involves establishing narratives and telling a story beyond just focusing on numbers. There are three approaches to valuation: discounted cash flow, relative valuation, and contingent claim valuation. Each approach has its own key variables that drive valuations. In relative valuation, it's important to keep an eye on pricing of similar assets. Real options models should only be used when there is exclusivity involved.

Valuation Approaches

In this section, the speaker discusses different valuation approaches and how to choose the right one based on the asset being valued, your profession, and time horizon.

Factors that Drive Choice of Valuation Approach

• Marketable assets can be valued using relative valuation.

• Unique assets may require discounted cash flow model for valuation.

• Time horizon is a key factor in choosing between intrinsic or discounted cash flow valuation.

• Beliefs about markets and how they make mistakes also influence choice of valuation approach.

Closing Thoughts on Valuation

• Keep an eye on the big picture when valuing an asset.

• Don't abandon first principles even if experienced individuals suggest otherwise.

• There is no guarantee that doing valuation right will lead to making money.

• Luck plays a role in successful valuations.

Fighting the Lemming Mentality

• The speaker uses valuations to fight against following trends blindly.