Valuation (Introduction Part 1)

The 7 most deadly words in investing

“They must know something that you dont”

3 broad themes of Valuation

  1. Valuation is simple we choose to make it complex
  2. Every valuation has a story. A good valuation is more about the story and not the numbers behind it.
  3. When valuations go bad its because of
    1. Bias
    2. Uncertainty
    3. Complexity


Types of Investors (Investors)

Momentum Investors

Look for a crowd they join in. Follow the crowd.

Yogi bear investor (lemmings)

They think they are smarter than the average investor.

They proud lemmings.

And at the last moment sell.

They claim to know when the edge is coming.

Investor with a life vest

Valuation gives you a life vest, it gives you something to hold onto when everyone decide to go the other way. Valuation slows the process down, gives your rational side a chance to mount an argument. Thats why valuation is important.

Why valuations fail (The Bermuda triangle of valuation)


Not starting with a blank slate. The irony is the more you know about a company the great the preconceptions are. And when those preconceptions get set the valuation suffers.

Ask two questions when you see a valuation:

  1. Who did the valuation?
  2. Who paid them to do the valuation ?


Valuation is a Science

All numbers are estimates. All estimates come with uncertainty. Estimating numbers are always going to be wrong.

One of the great ironies of doing a valuation is that the more uncomfortable you feel valuing a company, the greater the pay of is too doing the valuation.

If you make a model bigger its going to get better. Garbage in Garbage out.

Value a company with as minimum imputes, less is more.

3 Broad approaches to valuing a business

Intrinsic valuation

Value a company based on its:

  1. Its cash flows (Most common tool)
  2. Discount rate
  3. Life

Market makes mistakes when valuing a company based on Intrinsic valuation, and eventually corrects as a result.

Relative Valuation

Look at similar assets valued by the market at the moment.

Look for:

  1. Similar assets
  2. Look for comparable
  3. Control for differences

Applying option pricing models in the context of valuing assets that have continent cash flows

The asset / company will value only if something happens.

Examples are: a pharmaceutical company with a patent for a drug and the asset will appreciate only if it gets FDA approval.

Intrinsic valuation