Aswath Damodaran is a famous finance professor. He teaches corporate finance and valuation at the Stern School of Business at New York University. The talk given at Google has many valuable lessons to learn. The main theme of this talk is Valuation and Investing in general, the caveats, hurdles one face while valuation and gives common sense guidelines to investing in general.
Story vs Number People
Some people are born with story telling skills, they are hypnotic in telling stories, in contrast some people are born with numerical and computational skills, in valuation both skills matters, numbers without story and story without numbers just doesn’t work, Valuation is a game of telling story with appropriate numbers to support it.
Accountant vs Finance Perspective to Look a the world.
Accountants generally look backward, as what happened to the company in past, while Finance people has to look forward, as what is going to happen in Economy, Industry, competition and how that is going to affect the company, But there is nothing wrong about looking backward, many Finance people also look backward to get some indications on Financial health of the company.
Goodwill is a plug variable
Goodwill is a plug variable, it is like when accountants has no place to justify the premium payed for acquisition, he/she needs to put the surplus account somewhere, and that is the goodwill. One should not pay too much attention to this plug variable, it has been reported just to balance the assets and liabilities sides of the balance sheet.
Financial Balance Sheet
In many of his lectures and talks, he mentions about the “Financial Balance Sheet”, a financial balance sheet is a value perspective to look at conventional balance sheet, a financial balance sheet has growth assets and mature assets on Assets site, and how you fund business i.e Debt or Equity on Liability side.
Are Companies with Negative Cash Flows always Bad ?
For young growth companies value does not come from what the company has done last year, but it comes from future potential of the company, there can be negative cash flows for few consecutive years for these young growth companies, that does not mean that the company can not be valued or the company is a bad investment, negative cash flows makes sense, to drive future growth young companies has to put back their existing cash flows to drive future value.
Pricing vs Valuation
Most of the time what has been seen in analyst reports is pricing, that is relative valuation, it is like how a realtor decides price for your house, he or she looks into similar houses for and quote above or below based on the area and location of your house, likewise stock analysts looks for similar companies and their financial ratios and suggest target price for some stock to be either same or above those handful of similar stocks. That is not valuation in itself, there is a ample possibility that there is no company exactly similar to the company you are valuing, valuing happens in context of industry, economic values and competition in that industry.
Valuation is simple, and as most the value in the company comes from future but the future is highly uncertain, this leads to a natural behavior of inaction, Aswath Damodaran gives a very good advice in this case, he says one should do the best estimates on the future cash flows when faced with uncertainty, and this is a highly valuable advice, no one can be 100% right about value of any company, only one can make best assumptions and estimated for future cash flows. But even after all the hard work, luck is a dominating factor in investing success, you can do your best to value a company, comes with a bargain and there is a loss, and someone else just randomly picks stock and can be highly successful. Investing a game of odds, and if odds are in your favor you can be high lucky.
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Here is the complete video of Aswath Damodaran Lessons on Valuation at Google