The emails for this class will be collected in this file.
August 19, 2009
Hi folks,
I am sure that you are finding that summer is passing by way too fast, but the
semester is almost upon us and I want to welcome you to the Valuation class.
Note that this class was called Equity Instruments and Markets for the last
20 years that I have taught it but it was always about valuation. So, finally
I get to rename a class... One of the best things about teaching a valuation
class is that valuation is always timely. Anyway, I know that some of you are
worried about the class but relax! If you can add, subtract, divide and multiply,
you are pretty much home free... If you want to get a jump on the class, you
can go to the class web site
http://www.stern.nyu.edu/~adamodar/New_Home_Page/equity.html
The syllabus for the class is available and there is a google calendar for the
class that you can get to by clicking on
http://www.google.com/calendar/embed?src=4hi7pdbi2lmbra6g5m11e79rj8%40group.calendar.google.com&ctz=America/New_York
For those of you already setting up your calendars, it lists when the quizzes
will be held and when projects come due.
The first set of lecture notes for the class should be available in the bookstore
by mid-week. If you want to save some money, they can also be printed off online
(if you want to save some paper, you can print two slides per page and double
sided). To get to the lecture notes, you can try
http://www.stern.nyu.edu/~adamodar/New_Home_Page/eqlect.htm
Please download and print only the first packet on discounted cashflow valuation.
I will be updating the other two packets (yes, there are three...) to make them
more timely.....
The best book for the class is the Investment Valuation book - the second edition.
(The first edition won't be as useful... Sorry!) You can get it at Amazon or
wait and get it at the book store... Alternatively, you can use "Damodaran
on Valuation" or the "The Dark Side of Valuation" - again, make
sure that you are getting the second edition.
http://www.stern.nyu.edu/~adamodar/New_Home_Page/public.htm
I am looking forward to seeing you on Sept 9 - Wednesday at 10.30 at KMEC 2-60
to be precise.. I think we are going to have a lot of fun. Until next time...
Aswath Damodaran
adamodar@stern.nyu.edu
P.S: For those of you who were in corporate finance, the third edition of the Applied Corporate Finance book is available as a manuscript online, under books. If you have time and care to revisit the topic, I would love your feedback on the chapters and some proof reading.
September 1, 2009
Hi!
Not much news but I want to follow up on my last email from a couple of weeks
ago. (If you have no idea what I am talking about, then you may want to look
back at the emails from around August 15....
a. The lecture notes should be in the book store (or can be downloaded online
at
http://www.stern.nyu.edu/~adamodar/New_Home_Page/equity.html
Please download just the first packet.
b. While any of my valuation books (Damodaran on Valuation, The Dark Side of
Valuation, Investment Valuation) will work for the class, Investment Valuation
is the only one that is in text book format (with problems at the end of each
chapter). Whichever book you get, please get the second edition. You still have
time to buy it on Amazon and have it delivered in time for the class. (If you
are poverty stricken, you can live without the book...)
c. I have the Blackboard site for the class up but the website for the class
(listed above) will remain the key place to go to keep up with the class).
See you on Wednesday (Sept 9) at 10.30 at KMEC 2-60. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 9, 2009
Hi!
So, have you classified yourself yet? Are you a proud lemming, a "Yogi bear" lemming
or a lemming with a life-vest? While you are pondering that life-changing question,
I do have some points to make:
1. Please do find a group to nurture your valuation creativity, and a company
to value soon. If you are ostracized, please let me know...
2. Once you pick a company, collect information on the company. I would start
off on the company's own website and download the annual report for the most
recent year (probably 2006) and then visit the SEC website (http:www.sec.gov)
(for US listings) and download 10Q filings... If you can, also try to get to
a Bloomberg before the Corporate Finance people start monopolizing it and see
if you can print off the following pages for your company- BETA, DES (first 10
pages) and FA (income statement, cash flow and balance sheet numbers). If you
have never used a Bloomberg, try the write-up I have on my site on using a Bloomberg:
http://pages.stern.nyu.edu/~adamodar/pdfiles/Bloombergfull.pdf
3. The web cast for the first class is up. You can get to it by going to
http://www.stern.nyu.edu/~adamodar/New_Home_Page/webcasteqfall09.htm
You can either watch the live webcast or download the video file. Give me your
feedback.
If you did not get the syllabus, project description and the valuation intro
in class this morning, they are all available to print off from this site.
Just to restate what I said in class this morning, you can pick any publicly
traded company anywhere in the world to value. The non-US company that you value
can have ADRs listed in the US but you still have to value it in the local currency.
You can even analyze a private company, if you can take responsibility for collecting
the information.
Aswath Damodaran
adamodar@stern.nyu.edu
September 11, 2009
Hi!
In Wednesday's class, I made the claim that the biggest enemy of good valuation
was bias, induced both the preconceptions we bring to our valuations and the
biases added by the process. You may have dismissed my statements as hyperbole,
but I would like you to think about how bias impedes the process by considering
the following hypothetical scenarios, where you are the valuation analyst.
In each case, i would like you to consider the direction of the bias (High
value, low value, None) and the reason:
1. You are valuing your own business for sale to a third person.
2. You are a venture capitalist valuing this same business with the intent of
taking an equity stake in it.
2. You are valuing your own business for divorce court; half of your estimated
value will go to your spouse (soon to be ex-spouse).
3. You are an appraiser, working for the owner, valuing a business for tax purposes.
(Your estimated value will be used to assess estate taxes)
4. You are an appraiser, working for the IRS, valuing the same business for tax
purposes. (Your estimated value will be used to assess estate taxes)
5. You are a sell side equity research analyst, valuing a company with the intent
of putting a buy or sell recommendation on it.
6. You are an M&A analyst, working for the investment banker for the acquirer
in a friendly takeover, valuing the target company.
7. You are an M&A analyst, working for the investment banker for the target
in a friendly takeover, valuing the target company.
8. You are an M&A analyst, working for the investment banker for the acquirer
in a hostile takeover, valuing the target company.
9. You are an M&A analyst, working for the investment banker for the acquirer
in a hostile takeover, valuing the target company.
10. You are buy-side analyst, valuing a company for your portfolio manager, who
already happens to own a million shares of its stock.
11. You are buy-side analyst, valuing a company for your portfolio manager, who
already happens to have shorted a million shares of its stock.
My answers in class on Monday, and we can check..
I I do have a few articles that you may find interesting reading about bias in
valuation on the web site for the class under equity readings:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/eqread.htm
Do think about a company that you would like to value for the class. Remember
that you have the option of changing companies any time over the next few weeks,
if you have trouble... Finally, I thought you might like this lemming cartoon!
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 14, 2009
Hi!
The webcast for the class is up. Building on the last theme of matching cash
flows to discount rates, please take a look at the attached cash flows exhibit,
if you get a chance, before class. These are the forecasted cash flows for
a target company called Carborandum, made for the acquiring company (Kennecott)
by its enterprising and skilled investment bankers (First Boston). Here is
what I would like you to answer. Given the cash flows estimated in this table,
which of the following six discount rates is the right one to use in computing
the present value:
1. The cost of capital of Carborandum (13%)
2. The cost of capital of Kennecott (10.5%)
3. The weighted average of the costs of capital of the two firms (12%)
4. The cost of equity of Carborandum (16%)
5. The cost of equity of Kennecott (13.5)
6. The weighted average of the costs of equity of the two firms (14.5%)
Hint: Examine whether the cash flows are to equity or to the firm.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 16, 2009
Hi!
in the last two sessions, we discussed whether equity valued directly (by discounting
cash flows to equity at the cost of equity) will yield the same value as equity
valued indirectly (by valuing the firm and subtracting out debt). i know that
we really have not delved into valuation in depth, but if you are up to it,
try the first weekly challenge:
Since this is your first weekly challenge, I want to make sure that I don't
freak you out:
1. There will be no grade attached to this weekly challenge. Thus, there is
no payoff to doing this (other than developing a depth of understanding about
valuation and perhaps a small benefit on the quizzes) and no cost to not doing
it.
2. If you decide to try it out, give it your best shot. Save your answer. You
can submit it on Blackboard or send it to me as an attachment.
3. On Sunday, I will put up the solution to the weekly challenge.
4. If the answer matches yours, give yourself a pat on the back and move on.
If it does not, try to understand why the answers vary.
5. If you still don't get it, email me.
I know that you are busy, but I think this will cement your valuation principles.
Good luck!
Aswath Damodaran
adamodar@stern.nyu.edu
September 17, 2009
Hi!
I hope that the discussion of riskfree rates a left you fairly clear about
what to do next. In case, you are still confused, this is the next step in
the process:
1. Pick a company (in case you have not already)
2. Determine a currency that you will value the company in. Once you have
decided on the currency, find a riskfree rate in that currency. If your company
is a US or European company, you just got lucky. Use the 10-year T.Bond rate
as your riskfree rate for the US company and the 10-year Euro bond rate (pick
the lowest one -probably Germany or France) for the European company. (If you
have a non-Euro company, you should still be able to get a 10-year bond rate
from the Financial Times). If you are valuing a company in an emerging market
in the local currency (be brave), your job is a little more complicated.
2a. Get the longest term government bond rate you can get in the local currency.
Try the Bloomberg terminals. If that does not work, get online and search...
If that does not work, switch to a different currency.
2b. Get the local currency rating for the country by going to the moody's web
site: http://www.moodys.com (Look under sovereign ratings)
2c. Estimate the default spread given the rating by downloading the country
premium spreadsheet that I have attached to this email.
2d. Riskless Rate = Government bond rate - Default Spread given rating
I have a paper on riskfree rates that elaborates on the discussion in class
today. It is really not a painful read, if you can spare the time. You can
get to it by going to:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1317436
Just a note to remind you that the email chronicles have now been updated
online and you can find all old emails at:
http://www.stern.nyu.edu/~adamodar/New_Home_Page/eqemail.html
The fist three webcasts are up...I think this email has reached critical mass.
Have fun! Until next time!
September 19, 2009
Hi!
I hope you have had a chance to try the first weekly challenge that I sent out
on Wednesday. If you have not or have no idea what I am talking about, you
can get to it by going to the webcast page for the class:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/wkchallenge.html
The solution will be available tomorrow on the link and will be emailed to you.
I am also attaching the first newsletter for the class. It has nothing of earth
shattering importance in it, but it does contain information on where we are
in the class, where you should be on your project and some useful links. Please
browse through it, when you have a chance. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 20, 2009
Hi!
For those of you who did try the weekly challenge, thank you! I think you will
find this time well spent, at least in hindsight. For those of you who did
not, I know it has been a busy week. Perhaps, next week. I am attaching my
solution to this email and will post it online as well.
If you are interested in exploring this further, here is a spreadsheet that reconciles firm and equity values:
On a different note, there is an interesting article on dividends and buybacks
in the New York Times, from yesterday, that you may want to browse through.
It has implications for our discussion of equity risk premiums tomorrow.
http://www.nytimes.com/2009/09/19/business/19charts.html?scp=1&sq=buybacks&st=Search
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 21, 2009
Hi!
Building on what is going on in markets right now and today's session, here are
a few thoughts:
1. Country risk: The last few months should be a reminder of why country risk
is not diversifiable. As you see markets are volatile around the world, I think
you have a rationale for a country risk premium. You can get default spreads
for country bonds on my site under updated data. If you are interested in assessing
and measuring country risk, to get from default spreads to equity risk premiums,
you need two more numbers. The first is the standard deviation for the equity
market in the country that you are trying to estimate the premium for. Try the
Bloomberg terminal. Find the equity index for the country in question (Bovespa
for Brazil, Merval for Argentina etc.) and type in HVT. This should give you
the annualized standard deviation in the index - change the default to weekly
and use the 100-week standard deviation. Do the same for the country bond in
question. The two standard deviations should yield the relative volatility. If
you have trouble finding either number, just multiply the default spread by 1.5
to get a rough measure of the country risk premium. As for other sites that look
at country risk, here is one that you may want to look at. It is the site maintained
by Professor Campbell Harvey at Duke who does very good work on country risk:
http://www.duke.edu/~charvey/Country_risk/couindex.htm
2. Company risk exposure to country risk: My concept of lambdas for countries
is a work in progress. I have a paper on the topic on my website that you may
want to read, if you are so inclined:
http://www.stern.nyu.edu/~adamodar/New_Home_Page/papers.html
Check down the list of papers...
3. Implied equity risk premiums: A day like today is perfect for thinking about
implied equity risk premiums. As promised, I am attaching the excel spreadsheet
that will allow you to compute implied equity risk premiums. I am using the numbers
that I used in class today to arrive at an equity risk premium of 6.43%.
Please try to update the implied premium, using today's numbers for the S&P 500 (easy), T.Bond rate (easy), growth rate in earnings for next five years (Use 4% ) and updated dividends and buybacks over the last year. For the last input, you may want to read the attached from S&P.
4. Equity Risk Premium paper: Now that you have read and digested the riskfree
rate paper (just kidding), you should try this paper that I have on ERP...
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1274967
It is a long paper but I think it is a fairly easy read. Let me know what you
think!
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 23, 2009
Hi!
The big topic for this week was obviously risk premiums and the attached weekly
challenges should bring the lessons from class home. Please give one or both
challenges as shot. As always, I will nag you again on Friday and Saturday
and send you the solution on Sunday.
The first weekly challenge concerns emerging markets and how best to deal with the risk in them. The second one provides implied equity risk premiums, interest rates and Baa default spreads over time. See what you can extract as useful information from them.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 25, 2009
Hi!
As we move from discount rates to cash flows in the next session, here are some
ways to keep the discount rate estimation in control:
1. Assuming that you have picked a currency to do the valuation, estimate a riskfree
rate in that currency.
2. Estimate an equity risk premium for a mature market - the US historical risk
premium (3.9%) or the implied premium today (6.5% or whatever you compute it
to be) or the average implied equity risk premium for the US over time (4%) are
all contenders. As I noted in class today, this may be a point in time where
the current implied premium should be weighted more in your analysis, even if
you believe will revert back to historical norms over the long term. Use this
mature market premium for any country that has a AAA rating (most of Western
Europe, for instance).
3. Estimate the additional risk premium for the country or countries that your
firm has operations in that are not mature (less than AAA)... If your company
is in too many countries to do this, classify revenues by region of the world
and estimate an average regional risk premium (Asia is close to 3.5%, Latin America
is closer to 7%...)
4. Estimate a bottom-up beta for your firm, using comparable companies. You can
use the averages on my web site for different industries (http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html)
or you can do it on your own. The best resource, if you can get to it, is the
Bloomberg terminal. Type in ESRC and try screening for stocks, starting with
a narrow definition of comparable (same business, same region) first and then
expanding your sample. If your firm is in multiple businesses, estimate the values
of each of the businesses (try the revenue and EV/Sales route that I used for
SAP).
5. If you can estimate a lambda. This will require that you estimate what a typical
company in the risky country that your firm operates in. You can get rough estimates
of these numbers from the paper I have on measuring company risk exposure.
6. Bring it all together in a cost of equity computation.
7. Pat yourself vigorously on the back for a job well done.
I know I am a little fixated on bottom up betas versus regression betas (and
I should see a psychiatrist about this sickness). However, I did put together
this list of 10 questions on bottom up betas that may enlighten you on my obsession
and perhaps give you some ammunition when you have to argue with your colleagues
about which beta to use in the future... I hope it helps... if you can think
of any questions that I have missed, please do let me know.
I was going on to go on and talk about cost of debt, but I will not push my
luck in this email. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
P.S: Don't forget the weekly challenge(s) this week...
September 26, 2009
Hi!
Hope your weekend has begun well. I have attached the newsletter for this week
to this email. Please take a look at it when you get a chance.
Do you tweet? (When I get asked this question, I feel the urge to ask: Why? Are
you the big bad putty tat? If you don't get it, you have not been watching cartoons
enough..... Check out http://www.youtube.com/watch?v=rYaWX43bTW0) Seriously,
though, the news story yesterday about Twitter being valued at a billion has
set of a wave of breast beating (on the part of value investors, who are convinced
that this is the second coming of the dot com bubble) and the techno-investors
(who think it is a deal). I have a note on the valuation on my blog. (Yes.. I
do have a blog and I may tweet and I even text, though at abysmally slow rates...)
To read my profound thoughts, you can visit the hallowed site yourself:
http://aswathdamodaran.blogspot.com/
Let me know what you think! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
Nag 1: How are those weekly challenges coming?
Nag 2: So, what is the current implied equity risk premium for the S&P
500?
September 27, 2009
Hi!
For those of you who did try out the weekly challenges, well done... For those
of you who did not, there is always next week... And there is no class tomorrow!
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
September 29, 2009
Hi!
Hope you enjoyed the long weekend. Just a few notes for tomorrow:
1. We will begin the class with the current implied equity risk premium for the
S&P 500. I hope that a few of you will beat me to it.
2. We will complete our discussion of discount rates tomorrow. Since we are talking
about firm specific numbers - beta, default spreads, debt ratios - it would help
if you have already picked a company and started pulling up these numbers.
3. If you have pulled up a company, print off their latest financial statements
and bring them to class with you. It will help in our discussion of cash flows.
4. don't like to nag but I have noticed the drop off in attendance in class.
In understand that you have other things on your plate right now, and if you
do have to travel/interview, I am glad that the webcasts act as a backstop. However,
if you are able to make it to class, please do come, (No threats... i will continue
to put the webcasts up... So, the only thing I hope to have working for me is
moral suasion.)
Aswath Damodaran
adamodar@stern.nyu.edu
September 30, 2009
We are almost at the end of the cost of capital discussion. Here are a few
add ons:
1. Implied Equity Risk Premium for Sept 30, 2009: I am attaching the excel
spreadsheet with the updated equity risk premium number that we did in class
today. I am also attaching the S&P Buybacks report that I pulled off the
S&P website.
I did notice a mistake that I made on the buyback number in class that I think
I have fixed. Check for yourself. If we take the trailing 12-month number as
the new steady state, the equity risk premium is actually down to 4.82% (not
5.72%). if you average buybacks across the last decade,your equity risk premium
stay at about 5.5-6%.
2. Synthetic ratings and default spreads: To estimate the synthetic rating
and default spread for your firm, use the attached excel spreadsheet that has
the coverage ratio/ratings table built in. If you can, please collect information
on leasing commitments at your firm and input it into the spreadsheet as well.
It will give you a jump on the next class.
(Note that this spreadsheet requires you to have a check in the iteration
box in the excel calculation options... Please make sure it is there)
Let's sip the weekly challenge this week, since we have the quiz a week from
today. You can get access to prior quizzes by going to
http://www.stern.nyu.edu/~adamodar/New_Home_Page/equity.html
In case, you cannot get to it, here is the file with the past quizzes and solutions.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 3, 2009
Hi!
Not much to add to the news this week, since we had only one session. Next week
is a big week, though. We will work on cash flows on Monday and the quiz is
on Wednesday. It will definitely cover all aspects of discount rates - risk
free rates, equity risk premiums, betas, cost of debt and debt ratios. It will
also cover at least the adjustments that we have to make to earnings for leases
and R&D - which we will cover on Monday. In terms of chapters in the book,
the relevant chapters in Investment Valuation are chapters 1,2, 7,8 and 9.
Aswath Damodaran
adamodar@stern.nyu.edu
October 6, 2009
Hi!
First things first. Pursuant to our discussion of leases and R&D in class,
here are my thoughts:
1. Operating Leases: The core problem here is that lease commitments are contractually
set, tax deductible and there are consequences to failure. Thus, they meet all
of the characteristics of financial expenses (rather than operating expenses,
which is where they are categorized now). We went through the process of capitalizing
leases, but I noted the existence of a paper I have on the topic (I know... I
know.. Who has time to read these papers? But if you do...)
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1390280
It not only explains the process in more (even excruciating) detail but maps
out the effect on every input in valuation (from levered betas, to reinvestment
rates to return on capital to the final value per share).
2. R&D: Again, let me start with the rationale. A company invests in R&D
expecting to get benefits over future years, rather than the current one. That
again, meets the criteria for cap ex (rather than operating expenses, which is
where we find it now). I could send you another paper to read, but you are probably
sick of reading. Instead, I am attaching the excel spreadsheet that you can use
to convert R&D into a capital expense.
Finally, to the important stuff on the quiz. Note below the key details:
1. Timing: 10.30-11, Wednesday, October 7 (Don't be late). There will be class
after the quiz. So, please do stay. There will be coffee and donuts (not
really... but you cannot blame me for trying..)
2. Format: You can look at the past quizzes to get a sense of the format. The
quiz is open books, open notes. However, you cannot use laptops or maintain
connectivity (cell phones, iPods etc...) during the quiz.
3. Weight: The quiz is worth 10%.
4. Protocol for missing a quiz: You have to let me know, by email, that you
will be missing the quiz before 10.30 am tomorrow.
5. Consequences of missing a quiz: The 10% will be moved to your remaining
exams. In effect, your second and third quiz will be worth 12.5 points and
your final will be 35 points. However, you will lose the option of having the
score on your worst quiz moved up to your average score.
6. Getting ready for the quiz: Review the lecture notes (and the lecture webcasts,
if necessary). Work through the problems in the book, if you have the time.
The solutions are online on my website, under the website for the book. The
key is to work through as many practice quizzes as you can in real time (30
minute limit) and without peeking at the solutions. Get a good night of sleep
but make sure that your alarm is on.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 6, 2009
HI!
I thought I should summarize some of the questions that are coming up more than
once on the quizzes, with my responses...
1. When does a government bond rate need to be adjusted for default risk and
when not, in computing riskfree rates?
As a general rule, you should adjust the government bond rate for default risk
if the local currency rating for the government is less than Aaa. (How will
you know? It should be given in the problem) I am sorry that I have been a
little sloppy in past exams, especially the earlier ones, where I have given
the government bond rate for an emerging market, provided no information about
local currency ratings and used the bond rate as the riskfree rate. I will
try to be more careful.
2. What do I do if no equity risk premium is given in the problem?
If no premium is given in the problem (which would be dumb on my part) you
can use the current implied equity risk premium (4.82%, as per the implied
premium, last week, or even the 6.43%, the implied premium at the start of
the year). If a premium is given in the problem, please, please do not override
it.
3. How do I know whether a beta mentioned in a problem is a levered or unlevered
beta?
When a problem mentions a beta, that beta is always a levered beta. If I intend
to give you an unlevered beta, I will describe it as such.
4. What should I use as a tax rate, if none is given?
Use 40%... or 0% ... Just stay consistent. Again, do not override information
in the problem.
5. When a firm is in multiple businesses, how do I determine the weights to
use to get a bottom up beta?
The weights you should be using should be based upon the value of each business.
Practically, though, you are far more likely to get information on revenues
or operating income, by business. You can try to convert these revenues/earnings
numbers into estimated values, by applying a multiple to revenues or earnings.
Just make sure your weights add up to one.
6. Given that there are three approaches for estimating the country risk premium,
how I decide which one to use?
There are three approaches described in the notes to computed country risk
premiums - (1) the default spread, (2) the risk premium computed by looking
at the standard deviation of the local equity market relative to the US market
and (3) the melded approach, where the default spread is scaled up by the relative
volatility of the local equity market, relative to the government bond. To
see which approach you should use, look at the information given in the problem.
If you have information provided on the standard deviations of the equity and
bond, I would like to see you use the third approach.. If the information is
not there, you have to use whichever approach you have the information for.
7. When should I be estimating the lambda?
To estimate lambda, you need the raw information. In the revenue based approach,
I will have to give you not only the proportion of the revenues that the
company gets in the market but what the average company in the country gets
from the market. If the information exists, use it to get lambda. If not,
don't torture yourself (and me).
8. When I capitalize operating leases, why do I use the pre-tax cost of debt?
Because the lease commitments are pre-tax commitments, the discount rate has
to be a pre-tax cost of debt.
9. What default spreads should I used for the cost of debt?
In almost every problem, I give you the default spread to go with a rating.
If that is not given, use the most recent table you can find in your notes.
(There is one that gives you January 2009 numbers)
10. When we capitalize R&D, why do we not amortize the current year's
R&D expense?
When we use the year-end convention for cash flows (as opposed to mid-year
cashflows), the current or more recent year started 365 days ago and ended
today. Our cashflows/earnings occur at the end of each year. Consequently,
the current year's R&D was spent today. You cannot amortize what you spent
today.
Hope this helps (or at least does not hurt). Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 7, 2009
Hi!
Just pulled it off.. The quizzes are done and can be picked up on the 9th floor
on the table just in front of the entrance to the finance department. The quizzes
are in alphabetical order and face down. Please do not browse and take your
own quiz. I have attached the solutions to this email as well as a tentative
distribution.
I know that you are in no mood for finance now but the next weekly challenge is also attached. It will help you nail down the effects of leases and R&D. Give it a shot (and I will nag you later).
All of this stuff is also online on the webcast page for the class. I am off to London. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 10, 2009
Hi!
I hope that you have had a chance to pick up your quiz and check the solution
out. I do make mistakes while grading. So, if you feel that you have been unduly
penalized, come in and talk to me. I have also attached this week's newsletter.
Aswath Damodaran
adamodar@stern.nyu.edu
P.S: Don't forget the weekly challenge.
October 11, 2009
Hi!
Hope you are enjoying this spectacular fall day... I am and I have two basketball
games and a soccer game to look forward to.. Anyway, I know that most of you
wanted a break from valuation this week and did not try the weekly challenge...
If you did, thank you! If not, give it a shot when you do get a chance. The
solution is attached:
Aswath Damodaran
adamodar@stern.nyu.edu
October 13, 2009
Hi!
Now that we are talking about earnings and growth, here are a few things considering
about estimating this number for your company:
1. Forensic accounting: I did promise you a couple of references on forensic
accounting, where you look for clues to accountinf fraud in financial statements.
i am sorry it took me so long, but I got around to it finally. The first is by
Howard Schilit who just sold his forensic accounting practice for $ 50 million.
It is called Financial Shenanigans and the Amazon url is
http://www.amazon.com/exec/obidos/tg/detail/-/0071386262/qid=1076606632/sr=2-1/002-2407243-0189656?v=glance&s=books
The other is by Terry Smith, who used to work for an accounting firm in the UK,
until he decided to expose the seedy underbelly of accounting...
http://www.amazon.com/exec/obidos/ASIN/0712675949/qid=1076606899/sr=2-1/ref=sr_2_1/002-2407243-0189656
Needless to say, you need to have a firm grasp of basic accounting before you
get into creative accounting... Did you sell your accounting text book back to
the bookstore?
2. Growth Rates: On Monday, we talked about historical and analyst estimates
of growth for your company. if you want to look up one or both numbers, you can
get them by visiting either Yahoo! Finance (Check under analyst estimates) or
Mormningstar. If you are in school and can access Capital IQ, that would be even
better.
Finally, the second packet is available to download online. You can get to it
by going to the website for the class and clicking on either webcasts or lecture
notes. It will also be available in the bookstore in a couple of weeks. Until
next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 14, 2009
Hi!
This is your fifth weekly challenge and I know that the response has been spotty.
Of all the challenges that I send out, this may be the most important and I
would strongly encourage you to try this weekly challenge out. Not only does
it cut to the core of the terminal value computation, but it will stand you
in good stead on every valuation problem from this point on... So, please do
spend a few minutes (say, 15 minutes) on the one... You will not regret it.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 17, 2009
Hi!
Looks like a miserable weekend. So, you should have plenty of time to catch up
on valuation! Anyway, a couple of quick points (nags really).
1. Weekly challenge: As I noted in my Wednesday email, this week's challenge
is perhaps the most critical of all of them (not only for your quizzes and exams,
but for your understanding of valuation..) So, give it a shot! I am attaching
the challenge again, in case you have lost it.
2. Newsletter for this week: I have also attached the newsletter for this week. Even if you have made it a practice of never opening these (a worthy initiative), take a look at this one. Especially note where you should be on your DCF valuation...
3. Growth: Building on the theme that time is passing and that the date for
your DCF valuation submission is drawing near (about 2 weeks), you may want
to start collecting the items (or estimating them) that you will need for estimating
growth for your firm. In particular, getting a return on capital or equity
nailed down is the center of the process. Consequently, I think you may find
the attached paper on just this topic useful. I wrote it about a year ago but
it may help:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1105499
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
Octeober 18, 2009
Hi!
I am little groggy this morning. I was at the Yankee game last night.... all
13 innings of it... Freezing but all's well that ends well (at least if you
are a Yankee fan...) Did not get home until 2.30 pm.... However, I am not so
out of it that I would forget to send you the solution to the weekly challenge.
I notice that far more of you tried this one (perhaps, my prodding did work..)..
If you did not, take a look at it anyway.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 19, 2009
Hi!
No time like the present to introduce you to the papers on cash and cross holdings.
If you have Damodaran on Valuation (2nd edition), you already have this as
a chapter. If you don't, you can get pretty much that chapter by going to:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=841485
I hope you find it useful. On a related issue, I talked about closed end funds
this morning in class. You can get the latest pricing information on closed end
funds by going to:
http://www.closed-endfunds.com/
I cannot vouch for the site, but it seems pretty comprehensive (I am a little
suspicious that the sponsor is the Closed End Fund Association, though!) Check
out a few that trade at immense discounts. Perhaps, you have the makings of ruthless
tycoon...
Aswath Damodaran
adamodar@stern.nyu.edu
October 21, 2009
Hi!
I know that some of you are just turning your attention to the DCF valuation.
I fully understand, because you do have other things to take care of. Anyway,
I thought I would lend a helping hand:
1. Model building versus Model borrowing: This is not a modeling class and I
am fine with you borrowing and adapting my models. If you decide to build your
own model, keep it simple. Please do not use investment banking valuation models
that you may have borrowed from a prior or summer job. Not only do they add detail,
where you need none, but they often have fundamental mistakes built into them.
2. Which model should I use? First, go through the slides from a couple of sessions
ago where we developed a roadmap for picking the right model. Once you have decided
whether you want to use dividends, FCFE or FCFF, here is my suggestion. For companies
where operating margins are not likely to change dramatically, use one of the
ginzu models on my website. They are versatile and will do a lot a great deal
of your dirty work (capitalizing R&D, converting leases to debt, taking care
of management options) for you. For companies where margins are likely to change
over time or companies with negative earnings, use the higrowth.xls spreadsheet
(even if you do not expect high growth). In particular, stick with the following
choices:
a. fcffginzu.xls: if you are doing a FCFF valuation of a firm that has positive
operating income and you do not expect dramatic shifts in margins over time
b. fcfeginzu.xls: if you are doing a FCFE valuation of a firm that has positive
net income and you do not expect dramatic shifts in margins over time
c. divginzu.xls: for financial service firms
d. higrowth.xls: for any firm that has shifting margins over time, even if it
is not in high growth
You can find all four of these spreadsheets under spreadsheets on my website.
There is also a video that goes with the fcffginzu.xls spreadsheet explaining
how to use it. It also includes spreadsheets that will convert leases and R&D
and value options (I am a full service operation).
Let me clarify, though, what I would like to get from you when you turn it
in:
1. Each of you can turn in your valuation individually. You do not have to
submit as a group.
2. All I want is a base case valuation of your firm. It will be easiest if
you submit the excel spreadsheet containing your valuation and include your
assumptions page in the same spreadsheet.
3. There is no hard copy required and you can submit your DCF valuation spreadsheet
electronically. But please do the following:
In the subject enter: "My perfect DCF Valuation". Do not deviate
from the script or my filtering program will dump your email into my general
email pile.
In the email text, specify the name of the company that you are valuing (yes,
there are people who have submitted valuations of unnamed companies), the price
per share that the stock is trading at today and your estimate of value per
share.
4. Your DCF valuation will not be graded. I will review the valuation and send
you back your own spreadsheet with my comments embedded in the spreadsheet.
Some of the comments will be suggestions (which you are free to ignore) and
some will be stronger than suggestions (and these should probablyy not be ignored).
5. If you don't get back your valuation within 48 hours of submitting it, please
send me another email to let me know. My filtering program sometimes works
in mysterious ways.
6. If you get done before November 2, go ahead and send your valuation in early.
So, don't freak out about this deadline. It is more feedback on your valuation
than judgment day...
Aswath Damodaran
adamodar@stern.nyu.edu
October 22, 2009
i!
The latest weekly challenge is up online and is available online. If you get
a chance, please take a look at it.
I am sorry that I did not get it to you yesterday, but better late than never.
We also talked about transparency (and the cost of complexity) and equity
options in class today. As always, I have references on each that you may (or
may not) find useful.
On transparency: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=886836
On equity options:http://papers.ssrn.com/sol3/papers.cfm?abstract_id=841504
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 24, 2009
Looks like the rain has tapered off. (Thought I should put in some small
talk up front to lull you into a false sense of complacency... ) Anyway, a
few sundry items before your get back to your DCF valuation.
1. Newsletter: The newsletter for this week is attached. As always it is online...
2. Equity Risk Premiums: One of the inputs that you will have to enter for
your valuation is the equity risk premium (including country risk premium).
I just finished an update of the Equity risk premium paper last Friday that
you can access. It should all your questions about equity risk and the meaning
of life:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1492717
Take a look... (or just download the paper on to your computer and let it sit...)
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 25, 2009
Hi!
I am attaching the solution to the weekly challenge and also have it online.
I hope you had a chance to give it a shot. If not, you still have time..
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 28, 2009
Hi!
I know you have lots of things on your plate right now and may not get a chance
to do this, but I do have a weekly challenge for this week:
On a different note, I know that I have been a little hazy about what to do
with these weekly challenge. First, they are not mandatory. There is no grade
attached to them. The pay off, though, is both short term and long term. In
my years of teaching this class, no one who has done at least half of the weekly
challenges has ever got anything other than an A. That may be selection bias...
but that is the data. The long term pay off is that it will force you to get
past the mechanics and understand valuation. What matters to me most is that
you try to do the weekly challenges. Whether you turn them in to me or not
is not that critical.
I hope your valuations are going well. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 29, 2009
Hi!
The DCFs are starting to show up in my special mailbox (don't forget the "My
perfect DCF valuation" in the subject). Thank you and keep them coming.
While the official due date is November 2, I will be glad to get it earlier.
If you have issues with any of my spreadsheets, I will trouble shoot them (for
free). Just send them over. On a different note, the second quiz has been moved
to Wednesday, November 4. If you are one of those with a conflict with this date,
the early quiz will be right after class on Monday. The second quiz will cover
everything in lecture note packet 1 from page 100 on to the very end.. In effect,
cash flows, growth rates, terminal value and the loose ends (options, cross holdings
etc) are fair game. You can take a look at the past quizzes but you will probably
find that the earlier quizzes have more questions on multiples. Stick with the
latest quizzes and review the weekly challenges since the last quiz. The chapters
in the Investment valuation book that we will be covering are chapters 10-16.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
October 30, 2009
Hi!
The newsletter for this week is attached. I hope you get a chance to take a look
at it.
For the weekend, though, I know that you are working on your DCF valuations and I will not waste your time. I have received and returned about 20 of the valuations so far... and will continue to do so over the weekend. Just a head's up... I will be off to Philly tomorrow at about 3.30 pm and will not be back until Sunday morning. I am taking my three sons (a very expensive boys day out) to the Yankee game in Philadelphia. Since my ten-year old is insisting of wearing his entire Yankee attire, we may not make it back. (If you know Philadelphia fans, you know exactly what I am talking about.. )
On a different note, I know that a few of you are scheduled to take the quiz after class on Monday. Please meet outside my office at about 12 pm on Monday,. I have the exams and logistics worked out. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
November 1, 2009
Hi!
A quick update. I have about 50 of the DCF valuations and have returned about
44.... Will keep working on them..If you did have a chance to work through
the weekly challenge, here is the solution...
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
November 3, 2009
Hi!
Just a quick reminder that the quiz is tomorrow. The same rules apply: it is
open book, open notes and please let me know before 10.30 am, if you will be
missing it. I also have attached the quiz from Fall 2008, if you want to practice
more:
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
November 4, 2009
Hi!
I have to apologize in advance. While I am done with your quizzes, I cannot put
them out for you to pick up until I get into work tomorrow morning. I have
a teacher's conference at my daughter's school at 7.45 but should be in my
office by 9.45. The exams should be out by 10 am. The solution and score distribution
are attached to this email. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
November 5, 2009
By now, you should have received back your DCF valuation back. If you have
not, please send it to me. Rather than make myself into an all-knowing oracle
(which I am not), t thought I would take you through the process I used to
diagnose your DCF valuations.
Input page checks
Step 1: Currency check: What currency is this company being valued in and is
the riskfree rate consistent with that currency?
Right now, if you are valuing a company in US dollars, I would expect to see
a riskfree rate of about 3.5% here.. though some of you used 30-year bonds rates
which would give you a slightly higher value). if you are valuing your company
in pesos or rubles, I would expect to see a higher riskfree rate, (Watch out
for the tricky ones.. a Mexican company being valued in US dollars or a Russian
company in Euros.. Your riskfree rates should revert back to 3.5%, if this is
the case)
Step 2: ERP check: Is the equity risk premium being used consistent with where
the market is right now and where this company has its operations?
If you are analyzing a company with operations only in developed markets, I would
expect to see a number of about 4.5-5% here... That is because the current implied
premium in the US is about 4.97% (Oct 31, 2009). If you are using a premium of
6.43% (which was the premium of Jan 1, 2009, you will under value your company
whereas if you are using 4% (which was the premium prior to September 2008, you
will over value your company. If your company is exposed to emerging market risk,
I would expect to see something added to the mature market premium. While I begin
with the presumption that where your company is incorporated is a significant
factor in this decision, it should not be the only one in this decision. Coca
Cola and Nestle should have some emerging market risk built into them.
Step 3: Units check: Are the inputs in consistent units?
Scan the input page. All inputs should be in the same units - thousands, millions,
billions whatever... What you are looking are units with far too many digits
to make sense. (Check the number of shares. It is the input that is most often
at variance with the rest, usually because you use a different source for it
than the financial statements)
Step 4: Normalization check: If earnings are being normalized, what is the normalized
value relative to the current value? If reinvestment numbers are off, should
they have been normalized as well?
In some cases, we normalize earnings by looking at historical average earnings
or industry average margins. While this is perfectly defensible, you want to
make sure that the normalization is working properly. Thus, if earnings of $
3 million are being replaced with earnings of $ 3 billion, you want to make sure
that this company has generated earnings like these in the past. You may also
want to consider an alternative which is to allow margins to change gradually
over time rather than replace current with normalized earnings.
As a follow up, check the reinvestment rate for the firm. If it a weird number
(900%, -100% etc.), it may be because something strange happened in the base
year (a huge acquisition, a dramatic drop in working capital). A better choice
may be to average over time.
Output page checks:
a. High Growth Period.
Start by checking the length of the growth period and the cash flows during the
growth period. In particular,
- Compare the FCFF (or FCFE) to the EBIT (1-t) (or Net Income). Especially if
you are forecasting cap ex, working capital and depreciation independently, compute
an implied reinvestment rate
Implied Reinvestment Rate = 1 - FCFF/ (EBIT (1-t) or 1 - FCFE/ Net Income
Thus, if you have after-tax operating income of 100 and FCFF of 95, your implied
reinvestment rate is 5%
- Look at the expected growth rate over the period. Does it jive with your reinvestment
rate? (If you see a high growth rate with a low reinvestment rate, the only way
you can justify it is by calling on efficiency growth. For that argument to make
sense, your current return on capital has to be a low number... See the attached
excel spreadsheet that computes efficiency growth.
- If you are forecasting operating income, cap ex, depreciation and working
capital as individual line items, back out your imputed return on capital:
Imputed Return on Capital = Expected EBIT (1-t)/ (Base Year Capital Invested
+ Sum of all reinvestment through year t-1)
If you see this number taking off through the roof or dropping towards zero,
your reinvestment assumptions are unreasonable.
b. Terminal value
Start by checking to make sure your growth rate forever does not exceed your
riskfree rate. Then follow up by
- Examining your reinvestment rate in your terminal year, using the same formula
we used in high growth
- Backing out your implied return on capital (ROC = g/ Reinvestment Rate)
- Checking against your cost of capital in stable growth (you don't want to
get more than 5% higher and you do not want to set it lower forever)
I have a spreadsheet that can help in this diagnostic:
One common error to watch out for is estimates of terminal value that use
the cash flow in the final year, grow it out at the stable growth rate. That
locks in your reinvestment rate from your last high growth year forever.
c. Cost of capital
As a general rule, your cost of capital should be consistent with your growth
assumptions. Thus, you should expect to see betas move towards the stable range
(0.8-1.2) and your debt ratios to rise towards industry average. Thus, your
cost of capital in stable growth should be different from the cost of capital
in high growth.
d. Final value of equity
Check for danger sign, including
- Cash and cross holdings becoming a huge percentage of value
- Options either being ignored or being a huge number
Market Price
As a final sanity check, look at the current market price. If your value is
not even in the ballpark, go back and repeat all of the earlier steps...
Try it out with your own DCF valuation and then offer to do it for a friend...
Then, take your toolkit on the road. Pick up a valuation done by an investment
bank or equity research analyst and see if you can diagnose any problems in
them. You are well on your way to being a valuation guru.
I have also attached a full set of diagnostic questions that you can consider
in the context of valuation to this email.
Aswath Damodaran
adamodar@stern.nyu.edu
November 5,2 009
Hi!
I know quite a few of you are trying to plan your trips home. I have the date
for the final. It is December 16, 11.15-1.15 in KMEC 2-60. Since our last
class is December 14, this is about as early as you can get a regular final
exam date. If you have to take it even earlier, talk to me.
Aswath Damodaran
adamodar@stern.nyu.edu
November 7, 2009
Hi!
Newsletter for the week is attached... Hope you get a chance to look at it.
Aswath Damodaran
adamodar@stern.nyu.edu
November 10, 2009
Hi!
As we get deeper into relative valuation, I have a few suggestions. First, read
the chapter or chapters on relative valuation in the book... It will reinforce
what we do in class. Second, take a look at the market regressions on PE that
we went through yesterday. If you want to see more details, go to
http://www.stern.nyu.edu/~adamodar/New_Home_Page/data.html
The market regressions are towards the bottom of the page.
Third, and this may be the best use of your time, pick up a valuation (any one...an
equity research report... an acquisition valuation) and play devil's advocate.
Think of the story being told and what the potential holes in the story are...
it is a great way to reinforce your grasp of relative valuation.
Two final administrative points. The third and final lecture note packet is now
available online on the webcast page for the classes. I was planning to make
only 25-30 copies for the bookstore..... If we run out, we can always copy more.
The mystery project should be ready either tomorrow or the day after and will
be due on December 4....
Aswath Damodaran
adamodar@stern.nyu.edu
November 11, 2009
Hi!
As promised in class today, the weekly challenge on PEGY ratios... No real solution
but give it a shot anyway.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu