The emails for this class will be collected in this file.
January 14, 2008
Hi!
Happy New Year! I hope the break has gone well...Anyway, the break is approaching
its end and I will see you in class in two weeks. As you all know, this class
is called Equity Instruments and Markets but that is really a lie.... It is
a valuation class about valuing all kinds of businesses -small and large, private
and public, U.S and foreign. The last few months have been a sobering reminder
of how important fundamentals are and how often they get ignored in investing...
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 first set of lecture notes for the class are ready to be printed off. To
get to them, 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 relative valuation notes in a couple of weeks 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!) Almost as useful and a little
more compact is Damodaran on Valuation (again the second edition)...You can get
either at Amazon or wait and get them at the book store... Both books are obscenely
over priced and I apologize in advance. If you are truly budget constrained,
I will lend you one of my copies for the semester.... You can pay me back later
with your ill gotten gains from trading. I am looking forward to seeing you in
a couple of weeks (and I am not kidding).. I think we are going to have a lot
of fun. It will be an interesting few months as we work our way through recession
fears and sub-prime fall out. Until next time...
Aswath Damodaran
adamodar@stern.nyu.edu
January 24, 2008
Hi!
Thought I would get your attention with that subject line... I wish it were a
joke but it seems to be the very real problem that SocGen is facing today.
Anyway, this email is a reminder that your first class is Monday at 1.30 in
KMEC 2-60. The lecture note packet for the class is available both at the bookstore
(for a price) and online (for free). In case you did not get my last email,
everything you need for the class should be available at
http://www.stern.nyu.edu/~adamodar/New_Home_Page/equity.html
I think it a Chinese curse that goes: May you live in interesting times, but
we do live in interesting times. As we watch the market gyrate, the Fed react
and numerous market watcher opine, I hope this class will help you cut through
the BS that inevitably accompanies a market move.... See you on Monday!
Aswath Damodaran
adamodar@stern.nyu.edu
January 28, 2008
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 aÊcompany
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 (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/webcasteqspr08.htm
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
January 29, 2008
Hi!
I don't know whether you have had a chance to look at a valuation or equity research
report with the intent of searching for bias.... 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
January 30, 2008
Hi!
As you get your groups in place and pick companies to value, you may find some
time on the side to try the first weekly challenge, which is attached. As I
noted this morning, you do not have to work through this challenge and it is
optional. If you really want to grapple with valuation questions and truly
understand the inside details, I would suggest that you try a few of these
challenges. I will give you a 72 hour start before putting the solutions over
the weekend. You can send me your solution, if you get done before that. I
will probably not respond to the solution till time runs out.
On another front, I suggested that you take a look at equity research reports
that were accessible through Bobst... here is the link
http://library.nyu.edu/vbl/company/
Click on Investext under analyst reports and enter your NYU id and you should
be home free...
Aswath Damodaran
adamodar@stern.nyu.edu
February 1, 2008
Hi!
The first newsletter is attached. Not much news but take a look at it, if you
get a chance. It is also available online. By the way, do try to work through
the first weekly challenge that I sent on Wednesday. The solution will come
to you tomorrow evening.
Aswath Damodaran
adamodar@stern.nyu.edu
February 2, 2008
Hi!
Hope you had a chance to try out the weekly challenge (and thank you to those
who did...) The solution is attached and is online...
Aswath Damodaran
adamodar@stern.nyu.edu
February 4, 2008
Hi!
I hope that the discussion of riskfree rates and historical risk premiums 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
3. Now comes the fun part. Just to get ready for the next class, you have
to estimate a historical risk premium. If you are analyzing a US company, you
can get the historical premium out of my notes (4.79% for 1928 - 2007). You
can take a look at the historical data by going to updated data on my web site
and clicking on historical returns. Try different historical return periods
and see what the premium looks like....If you have a non-US company, don't
even bother estimating a historical premium. If you are interested in getting
a jump on country risk premiums, try the following:
a. Bond rating for your country from http://www.moodys.com (Look under sovereign
ratings)
b. Default spread to go with that rating. Look in the attached spreadsheet.
If you are interested in reading up more on historical risk premiums, take
a look at the book "The triumph of the Optimists". You can get it
at Amazon by going to
http://www.amazon.com/exec/obidos/tg/detail/-/0691091943/qid=1075743432//ref=sr_8_xs_ap_i3_xgl14/002-6685221-2379210?v=glance&s=books&n=507846
Just a note to remind you that the email chronicles have now been updated online and the webcasts are up and running...I think this email has reached critical mass. Have fun! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 6, 2008
Hi,
I know that we have covered a lot of issues in the last two sessions and I
don't blame you if you feel a little overwhelmed. If you are (or even if
not), you may consider doing the following:
1. Read the chapter on estimating riskfree rates and risk premiums in Investment
Valuation (chapter 7). While it says much the same thing that was said in class,
it may be a little easier to work with.
2. If you get a chance, read the paper that I have on estimating company risk
exposure to country risk. It is available under the readings for the equity
class and under research/papers on my web site. It will provide more insight
into lambdas and country risk.
3. The best way to understand both country risk premiums and implied equity
risk premiums is to try your hand at estimating them on your own. I am attaching
two weekly challenges this week, one on country risk and the other on implied
premiums. You can do one, both or neither (if you are so inclined). 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
We also considered an alternative to historical risk premiums in class today
- the implied equity premium. To get a sense of how it works, try working with
the attached spreadsheet. (Ignore the macro... it is not used in the spreadsheet)
As a final note, we will complete the discussion of risk premiums and move on
to betas. It would nice if you could print off the beta page for your company
from Bloomberg and bring it with you. It is fairly easy to do once you find your
company (under equity) on a Bloomberg terminal. Type in BETA and you should see
a page with a scatter plot to the right and the statistics to the left. Print
it off. If there is no one waiting behind you for the machine, try the following.
Replace the default index on the page (it is the local index) with NFT (which
is the Morgan Stanley Capital Index) and bring the output as well. Until next
time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 8, 2008
Hi!
Very quick note. First, the newsletter for this week is attached. Second, the
weekly challenge is still live. If you get a chance, try it... The solution
will be up tomorrow!
Aswath Damodaran
adamodar@stern.nyu.edu
February 9, 2008
Hi!
The solutions to the second weekly challenges (both of them) are attached. They
are also online. On a different note, we will move through the beta, cost of
equity and capital discussions at hyper speed next week. If your corporate
finance is rusty (or you don't have any idea what a bottom-up beta or synthetic
rating are), it may help to read chapters 7 and 8 from the Investment valuation
book before class next week.
Aswath Damodaran
adamodar@stern.nyu.edu
February 11, 2008
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 (4.9%) or the implied premium today (4.15% or whatever you compute it
to be) or the average implied equity risk premium for the US over time (4%) are
all legitimate contenders. 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 2%, Latin America
is closer to 5%...)
4. Estimate a bottom-up beta for your firm, using comparable companies. You can
use the averages on my web site for different industries 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 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
February 12, 2008
Hi!
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.
Aswath Damodaran
adamodar@stern.nyu.edu
February 14, 2008
Hi!
Now that talk of estimating earnings correctly - updating, normalizing and fixing
accounting issues - is getting started, you may want to try the weekly challenge
on the topic. I would also suggest that you take a look at the financial statements
for your firm and start working towards nailing down a reasonable measure of
earnings. This will require:
a. Looking up any lease/rental commitments: Most companies report these in their
annual reports (and in the US, in the 10K). Once you look up the commitments,
you can compute the present value of leases using the pre-tax cost of debt (if
you don't have one, use the ratings spreadsheet that is attached before you use
the operating lease conversion sheet which is also attached)
b. Looking up R&D or similar capital expenses that are being treated as operating
expenses: This is a little dicier since it will require you to make an assumption
about amortizable life (and to get historical data). The attached spreadsheet
can help in making that computation.
c. Checking for extraordinary items/one-time charges
d. Look at earnings history for your firm and at sector averages to get a sense
of whether you should be normalizing the numbers
I know that we have not discusses operating leases or R&D expense conversions
in class yet, but the attached weekly challenge may allow you to get a jump on
the process. Chapters 9 and 10 in the investment valuation book will provide
the backgound... iUntil next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 15, 2008
Hi!
I am sure you are hard at work on your valuation right now... (Not likely, but
no harm dreaming....) If you do get a chance, give the weekly challenge a shot.
I will not put the solution up until Monday. I am also attaching the newsletter
for this week... Hope you get a a chance to browse through it.
Aswath Damodaran
adamodar@stern.nyu.edu
February 16, 2008
Hi!
I was forwarded this article on Yahoo! and DCF valuation. Take a quick read and
see if you can critique it (Trust me... You have the tools to take this apart...)
Hope your weekend is going well and I will see you next week!
Earlier this week, we covered Yahoo’s brief, polite rejection of Microsoft’s bear-hug letter. In making the determination that Microsoft’s bid “substantially undervalues” its assets, Yahoo had the benefit of advice from three investment banks.
They likely provided Yahoo with a valuation of the company, one that presumably asserted that Yahoo was worth a lot more. But how reliable is such valuation information? The understanding and pricing of assets is a relatively young discipline that has made revolutionary strides in the past four decades. However, there are still substantial problems with valuation practices that make them a useful tool, but one that should be viewed with a wary eye.
First, there are a number of different valuation methods. Two common and accepted techniques in the context of mergers and acquisitions are discounted cash-flow analysis and a comparable-companies analysis.
A discounted cash-flow analysis calculates the present value of the future free cash flows of a corporation by discounting the cash flows at a specific discount rate.
A comparable-company analysis typically compares the corporation being valued against selected, similarly situated, publicly-traded companies. These companies are compared using price multiples of each corporation’s stock against selected benchmarks, such as price to future earnings, price to forecasted sales, or price to book value.
Both are prone to subjectivity.
For example, a discounted cash-flow analysis is conducted by discounting back at a chosen discount rate the projected future free cash flows and terminal value of an asset. In performing this analysis, there are three central choices to make, each of which can significantly affect the final valuation. These are the correct forecasted free cash flows to utilize, the appropriate discount rate and the terminal value of the asset. There is substantial leeway to determine each of these, and any change can markedly affect the discounted cash-flow value.
Keep in mind that an increase of one percentage point in the discount rate on a stream of cash flows in the billions of dollars can decrease the discounted cash-flow value by tens if not hundreds of millions of dollars.
In the case of a comparable-company analysis, the subjectivity arises in choosing the comparable companies.
The highly subjective nature of valuations rears its head most acutely with fairness opinions. A fairness opinion is an opinion typically provided by an investment bank to an acquisition target that the price being paid by an acquirer is fair from a financial perspective. The opinion is often prepared using the valuation techniques above.
But investment banks are usually under pressure from their clients to come to the “right” answer on fairness. Moreover, investment banks are often conflicted in providing theses opinions, because their compensation is often contingent upon completion of a transaction (and, by extension, their finding of fairness) or they may want to preserve a future stream of business. The subjectivity of valuation and the conflicted nature of banks makes the process vulnerable to manipulation to arrive at fairness.
To illustrate these issues, let’s look at the recent disclosure made by Activision, the video game maker, concerning the fairness opinion provided to it by Allen & Company.
Activision is acquiring Vivendi Games based upon a valuation of Vivendi Games at $8.12 billion and a per-share price for Activision common stock of $27.50. Simultaneously with this acquisition, Vivendi is purchasing from Activision 62.9 million newly issued shares of Activision common stock, at $27.50 per share. After the closing of the transaction, the new Activision will commence a cash tender offer for up to about 50 percent of its shares not owned by Vivendi.
If the tender offer is fully subscribed, Vivendi and its subsidiaries are expected to end up owning about 68 percent of Activision.
This is a complicated transaction, made more so by the fact that Activision will remain a public company and Vivendi Games is a private company, making its valuation difficult. Nonetheless, Allen & Company has opined that these transactions are fair, from a financial point of view, to Activision and its shareholders.
Activision shareholders are required to approve this transaction, and the analyses underlying Allen & Company’s fairness opinion are disclosed in the proxy statement for this vote.
First, let’s look at the disclosure concerning the discounted cash flow performed by Allen & Company on Activision.
Discounted Cash Flow Analysis. Allen & Company’s DCF approach was based upon certain financial projections and estimates for Activision derived from Wall Street analyst reports. Allen & Company used a DCF analysis to identify a range of present values for Activision’s common stock based upon terminal forward P/E multiples ranging from 21x - 25x and discount rates ranging from 12% - 13%. Allen & Company determined that the per share transaction price [$27.50] exceeded the range of values indicated by its DCF analysis.
There are a couple of interesting things here. First, Allen & Company did not use Activision’s internal projections but rather Wall Street estimates. This occurs sometimes; if Allen had used Activision’s own projections, they would have been required to be disclosed. Activision may not have wanted this to happen. In addition, sometimes useful internal projections simply don’t exist. In such circumstances, the bank will take guidance from their client as to which estimates are the “best.” But Allen & Company has not disclosed the estimates utilized, so we cannot ascertain whether they are appropriate.
Moreover, in presenting its discounted cash flow, Allen & Company has not disclosed how it derived its discount rate, the number of years of projections used or what its calculated per-share price ranges were. In short, the description of the discounted cash flow is not particularly helpful if you wanted to make your own assessment of Allen & Company’s calculation.
A bigger potential problem with this disclosure is revealed when we look at Allen & Company’s discounted cash flow disclosure for Blizzard Entertainment, which makes the popular Web-based tame “World of Warcraft” and is the main component of Vivendi Games:
Discounted Cash Flow Analysis. Allen & Company estimated the after-tax unlevered free cash flow for Blizzard Entertainment beginning with the second quarter of 2008 through year-end 2012. Projections for 2008 and 2009 were obtained from Vivendi Games management, and Allen & Company extrapolated from these projections Blizzard’s results for 2010 through 2012. Allen & Company discounted the free cash flows back to a present value as of December 1, 2007 using discount rates ranging from 10.5% to 12.5%. In addition, Allen & Company assumed perpetuity growth rates ranging from 4.0% to 6.0% in order to calculate a terminal value. Using the midpoint for the range of discount rates of 11.5% and a range of perpetuity growth rate assumptions from 4.5% to 5.5%, the DCF analysis indicated an enterprise value for Blizzard Entertainment ranging from $7.7 billion to $8.8 billion.
This disclosure here is more fulsome. Unlike in the case of Activision itself, the proxy details more specifically how Allen & Company calculated its terminal value, the number of years of projections used and actually provides a range of values. Not surprisingly, the values are quite close to the actual price being paid by Activision to acquire Vivendi Games, since Blizzard is the primary component of this division.
But there are some odd things here. First, the discount rate here (11.5%) is lower than the range used for Activision (12%-13%). The lower the discount rate, the higher the value of the company. Since these two companies are in the same business, you would expect them to be assigned the same discount rates — or at least see a calculation using the same ranges.
The odder thing is the perpetuity growth rate assumption. This assumption is used to calculate the terminal value of the asset. It projects the cash flows out for the terminal value using an estimated future stable growth rate for the company.
This “perpetuity growth rate” figure cannot exceed the growth rate of the national economy, generally a real figure of 3 percent to 4 percent. Otherwise, the company would eventually become bigger than the whole economy — a clear impossibility. And the higher the rate, the more the company will be worth. Based on the numbers above, I estimate that a 3 percent perpetuity growth rate would reduce the discounted cash-flow value by about $1.35 billion.
There may be an explanation for this — use of a nominal rather than a real number perhaps — but without the comparable numbers for Activision, it is hard to make a determination.
And again, one has to wonder about why Allen & Company used a different method to calculate terminal value for Activision — a multiple method rather than a perpetuity growth rate. Why?
The lack of full disclosure and the use of different numbers and methods raises more questions than answers. We asked Allen & Company to comment on the fairness opinion Friday, but they declined.
The Activision opinion gets at a broader problem with fairness opinions and valuation generally. There are no guidelines or standards for valuation, and the banks often do not disclose enough information in proxy statements to make any meaningful comparison or assessment. In other words, the problems above with Allen & Company’s disclosure are quite common with proxy-statement disclosure of fairness opinions and valuation. Occasionally, the Securities and Exchange Commission will crack down on this and require greater disclosure, but they haven’t been successful in the longer term.
Because of all this, many believe that fairness opinions are not worth the paper they are printed on. Marc Wolinsky, a partner at Wachtell, Lipton, Rosen & Katz, seemed to suggest as much when he quipped in October: “A fairness opinion — you know, the Lucy sitting in the box: ‘Fairness Opinions, 5 cents.’”
At this point, I’d have to agree.
Fairness opinions are effectively required in M&A transactions by the Delaware courts, but the courts would do well to end this requirement so that fairness opinions can be assessed and obtained on their merits. Then this whole game of half-disclosure can stop. In the meantime, rely upon them at your risk.
Aswath Damodaran
adamodar@stern.nyu.edu
February 18, 2008
Hi!
I hope you had a relaxing long weekend. However, it is my unpleasant duty to
remind you that the weekend is now officially over. Anyway, a few items for
the coming week:
1. Solution to weekly challenge #3: I have attached the solution to the third
weekly challenge. Please do take a look at it when you get a chance.
2. Earnings and Cash flow estimation: We will be continuing with and completing
our discussion of cash flows and earnings tomorrow. If you really want to get
a jump on the process, you can convert operating leases into debt and R&D
into capital expenses for your firm. To do so, you need the following:
a. Leases: You need a schedule of lease commitments for the future. This is
required for US companies and can be found in the 10K and annual report in
the footnotes (I would download the 10K as a pdf file and do a search for leases
and rental commitments. Once you have the lease commitments, you can use the
excel spreadsheet attached (or online) to do the conversion. Note that you
will be asked for the pre-tax cost of debt for your firm and if you do not
have it, the spreadsheet will compute it for you.
Note that not all US companies have lease commitments and that many non-US
companies do not break out their lease commitments. If you can get the current
year's lease or rental expense, you can treat it as an annuity for 8-10 years...
Not perfect, but the best you can do under the circumstances.
b. R&D: To convert R&D expenses into capital expenses, you have to
make a judgment about how long it takes for R&D to pay off as a commercial
product in your business. For pharmaceuticals, that may be as long as 10 years.
In software, you are better off using 2-5 years. Once you have made this judgment,
you will need to get R&D expenses for the past for as many years as you
concluded it will take R&D to pay off. That information is available in
financial statements and on Bloomberg. As a final step, you can use the attached
spreadsheet (also online) to make the conversion:
I know that you are busy and that you might not be able to get to this, but
do what you can.
3. Quiz 1 coming up: The first quiz is a week from tomorrow. It will cover
everything we do through Monday. Tentatively, it will include introduction
to valuation, the basics of DCF valuation and estimating discount rates, cash
flows and growth. (Chapters 7-11 in the investment valuation book). It is open
book, open notes and you can look at past quizzes by going to the website for
the class (Some of the past quizzes cover topics that go beyond the growth
rate... Ignore those problems).
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 19, 2008
Hi!
I hope you had a wonderful weekend. It is my job to break the spell. Some notes
ahead of tomorrow's class:
1. Risk premiums: We ended the last session with a discussion of the historical
risk premium. Tomorrow's class will begin with an alternative approach to estimating
equity risk premiums, where we will back out the premium from the current level
of the S&P 500 index. If you want to get a jump on the process, try the attached
spreadsheet. The only numbers you will have to update is the current level of
the S&P 500 index and the treasury bond rate today (in red). I have updated
all the other numbers for you. Bring the output with you to class, if you do
it.
2. Betas: We will also begin our discussion of the conventional approach to estimating betas - running a regression of stock returns against a market index. If you can get to a Bloomberg, find your stock and print off the BETA page (you might already have done this, in which case you are all set) for it and bring it to class, it would be immensely useful. In fact, you can get part of the project done if you enter the numbers from your company's BETA page into the attached risk diagnostics sheet.
I know... I know.. You are still in weekend mode... So, do what you can and
I will see you in class tomorrow! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
February 21, 2008
Hi!
No weekly challenge this week, but if you did not get a chance to do last week's
challenge, you can go back and try it. (It is online on the webcast page for
the class....) Building on the theme of cleaning up earnings for valuation,
you may want to look at the paper that I have on measuring returns on equity
and capital on my website under research/papers. It will provide a solid foundation
for next week's sessions on growth. Forensic accounting (where we look through
financial
statements for suspicious fingerprints...) is relatively recent, but
I have a few suggestions for books, if you are interested. 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?
As noted in my last email, the quiz will cover everything we do through Monday
(where we will finish the discussion of cash flows and get a good way through
the estimation of growth. It will be in the first 30 minutes of class next Wednesday
and there will be class after the quiz... And, one final thing... The second
lecture note packet is ready to print off online (and the third will be shortly...)
It will also be in the book store in the next few days.
Aswath Damodaran
adamodar@stern.nyu.edu
February 22, 2008
Hi!
Ahead of the weekend, see the newsletter for the week.... As for next week,
we will talk about estimating growth rates in both sessions, interspersed
with quiz 1 on Wednesday from 1.30-2. If you get a chance, you can look up
two numbers ahead of next week's discussion:
1. The historical growth rate in earnings for your firm, over the last year
and the last 5 years.
2. Any analyst estimates of future growth
You should be able to get both at
http://www.marketguide.com
The first is under Financial Highlights and the latter is under estimates (the
LT growth rate is the estimate of growth over the next 5 years). If you have
a non-US company, it will take a little more work but you should still be able
to find at least the first.
Aswath Damodaran
adamodar@stern.nyu.edu
February 28, 2008
Hi!
The quizzes are done and can be picked up just outside the front door for the
finance department. They are in alphabetical order and face down. Please take
just your quiz and resist the temptation to browse. I have attached the solution
to the quiz and the distribution (though you should read too much into a distribution
of one quiz...)
Aswath Damodaran
adamodar@stern.nyu.edu
February 28, 2008
Hi!
I know that you are probably in no mood for valuation questions but I have attached
the latest weekly challenge. If you get a chance, please give it a shot. I
will be out of town tomorrow and day after, but will put the solution up by
Monday...... Hope you have a great weekend!
Aswath Damodaran
adamodar@stern.nyu.edu
February 29, 2008
Hi!
Hope you have had a chance to pick up your quiz... and check out the solution.
This is also a good weekend (an excellent one) to get your DCF valuation more
complete....The first round (which is not graded) is due just before the break.
The weekly newsletter is attached.
Aswath Damodaran
adamodar@stern.nyu.edu
March 2, 2008
Hi!
If you did try the weekly challenge, the solution is attached. If you did not,
please do take a minute to browse both the challenge and the solution (online
under the website for the class). if you have no idea what I am talking about,
just move on... Hope you have a great Sunday! Until next time!
adamodar@stern.nyu.edu
March 7, 2008
Hi!
As you take off for the weekend, some points to ponder. First, I know seem the
loose ends that we are dealing with right now seem like diversions but they
can cause big shifts in valuation. If you are interested in reading up more
on the topic, I have papers on each of the loose ends under research/papers
on my site. Please check out the loose ends section. I must confess the papers
are long but I don't think they are too much of a grind to read. I hope you
get a chance to browse through them. I have also attached the complexity worksheet
in case you feel the urge to read the 10K for your company this weekend.
On a different note, I am attaching the weekly challenge for this week. Since
it deals with terminal value, and this is where real screw-ups in valuation occur,
please do try to work your way through the challenge. As always, the solution
will be sent to you this weekend. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 9, 2008
Hi!
Hope your weekend is going well. Three very quick notes. First, the solution
to this week's weekly challenge is attached. Please take a look at it when
you get a chance. Second, I hope that you have been working through your DCF
valuation. My advice is that you keep it simple and focus on the big picture.
If you are using the fcffginzu.xls spreadsheet, you can get the webcast that
goes with it by going to
http://www.stern.nyu.edu/~adamodar/podcasts/fcffginzu.mov
Hope it helps....
Please keep in mind that your first iteration of the DCF valuation is due this
Friday. I will send you more explicit directions on what to do and how to submit
it tomorrow...
Finally, I don't know whether you got a chance to read the NY Times Business
section but there was an interesting article by Mark Hulbert on a paper by Ken
French about how much money investors have collectively spent to earn excess
returns over time. I am linking to the article...
http://www.nytimes.com/2008/03/09/business/09stra.html?ref=business
See you tomorrow! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 10, 2008
Hi!
First, about your DCF valuations. 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. I
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 Friday, 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...
Second,I want to return to some details relating to the loose ends discussion
we had in the last two sessions.
1. Dealing with cash: There are two ways of dealing with cash. One is to let
it be part of income, to adjust to discount rate for its existence and value
with the cash as part of the firm. This is what we do when we discount the net
income (which includes interest income from cash) at a cost of equity (where
the beta used reflects the cash holdings of the firm - the unlevered beta will
be lower because of the cash holdings). The second (and more precise way) is
to keep cash out of the valuation till the end. This is what we do in firm valuation
when we discount the operating income (which does not include the interest income
from cash) at the cost of capital (where the unlevered beta should be only on
operating assets...) Do not
- double count cash by including interest income from cash in your cashflows
and adding the cash balance at the end
- adjust your unlevered betas for cash holdings if you are discounting income
that does not include interest income from cash
2. Cross Holdings: It is a mess and I am sorry. The fault lies with the accountants.
The cleanest thing to do is to value the parent company as a stand alone business
and then value each cross holding separately and add the percent of the equity
in each crossholding to the parent company equity value. This may be impractical
if your firm has dozens of crossholdings and/or does not provide you with information
on them. If this is the case, try the following:
- For minority holdings: Take the book value of the holdings (which should show
up as an asset on your balance sheet) and multiply by a price to book ratio reflecting
the businesses in which these holdings are. (I have average price to book ratios
on my web site). Add this to the market value of your equity. (If you are doing
equity valuation, make sure that you don't double count the income from these
minority holdings in your net income)
- For majority holdings: Take the minority interest on your balance sheet, multiply
by a price to book ratio reflecting the business of the subsidiary. Subtract
this from your firm value (like debt) to get to the value of your equity.
3. Management Options: Check your 10K for options that are already outstanding.
Value them, using a dilution adjusted option pricing model, and then subtract
them to get the value of equity in common stock... Value all of them - in the
money, out of the money, vested and non-vested... As some of you have probably
noticed, valuing options with dilution creates a bit of a circular reasoning
problem. You need the value of the options to adjust the stock price and you
ned the stock price to estimate the option value. I try to deal with it by using
the circular reasoning option in Excel (which you can turn on by going to calculation
options and checking the iteration box). If you use any of my ginzu models, please
turn on this option. Otherwise, you will either get values that don't change
or valuation errors....
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 21, 2008
Hi!
I hope you has great break. If you did send in your DCF valuation, I think I
have sent them all back with my feedback (skimpy though it might be). If you
have not got your DCF back, please let me know. it is entirely possible that
you did not title your valuation "My Perfect DCF Valuation" and it
has gone into one of my other mailboxes but I will dig it up and get it back
to you. At the risk of picking at scabs, let me recap what I found across valuations
(though some or all of what I have to say might not apply to your valuations).
1. Bias towards growth and excitement: There was clearly a bias towards picking
growth companies that were exciting. i think it is natural to be drawn to these
companies. There were still the morbid few (or the unlucky few) who dealt with
GM, Bear Stearns or pretty much any financial service firm.
2. The Data conundrum: As many of you probably noted, the problem you faced was
not too little information but too much and often contradictory information.
The valuations that I thought ran into the most trouble were the ones that broke
things down into too much detail and tried to forecast individual items. It is
very easy in valuation to lose the forest among the trees and that was a common
theme. There is no harm in focusing on detail, but it only makes sense when you
can keep your perspective on the overall relationship between growth, risk and
cash flows. (I came to dread any spreadsheet with links to Capital IQ.. These
guys may provide a lot of data but they drown you in it...)
3. The Terminal Value Reinvestment link: If there was a fatal error in some of
the valuations, it came from assuming the unsustainable in terminal value calculations
- growth forever with no net cap ex, for instance. Most of you did compute the
reinvestment rate in stable growth, using a return on capital in stable growth
periods, but that number is worth thinking about. After all, this is the number
that McKinsey insists should be set equal to the cost of capital. While that
may be extreme, it is also unlikely that the return on capital can be 10 or 12%
higher than the cost of capital. While I am reluctant to force a number on you,
please do think carefully about the competitive advantages your company has before
you choose this number; the industry average may not always be the best choice.
4. The Market Price fixation: Much as we have discussed this in class, the sense
that some seem to have when they get a value that is significantly different
from the market price is that they screwed up. While this is a good place to
start, it s not a good place to end... Otherwise, you will find yourself playing
with the numbers till your value equates to the price.
One final point. There are 100+ people registered in the class and I did not
get some of the valuations. Since there is no grade involved here, I won't hold
your feet to the fire or harass you if you have not turned your valuation in.
Instead, I have attached a list of questions that I go through when I have a
DCF valuation (an error check list, if you want to call it that). You can use
it on your own valuation to get your diagnostics. I would recommend it even if
you have feedback from me.. it is a good way to learn how to go over a DCF valuation
and look for inconsistencies (or build your valuation error check macro...)
One final reminder. Please do print off a copy of packet 2 for next week's classes.
Aswath Damodaran
adamodar@stern.nyu.edu
March 24, 2008
Hi!
As I noted in class today, you have a quiz a week from today. While the syllabus
states that it will cover relative valuation, it lies... It will cover the
parts of DCF valuation we did not cover on the first quiz - valuing cash and
cross holdings, employee options etc. and doing full fledged valuations...
The best way to prepare for this quiz may not be past quiz 2s since they cover
a lot of relative valuation (though the last 2 should have roughly the same
break down as this one).. Try the problems at the end of chapters 12,13,14,15,
16 of Investment Valuation.... If you are interested in playing around with
my Google or Amazon valuations, they are both online. The Google valuation
is one the front page of my web site and the Amazon valuation should be under
the company examples under the equity instruments class page...
On a different note, I am attaching a spreadsheet that will allow you to compute
the probability of distress based on a bond price... similar to what we did with
Global Crossing today. Take a look at it when you get a chance...
Aswath Damodaran
adamodar@stern.nyu.edu
P.S: Please do not forget to print off packet 2 for class on Wednesday.
March 25, 2008
Hi!
In advance of tomorrow's discussion of the dark side of valuation, I am attaching
the valuation of Google I did in 2006. I am working on a 2007 valuation that
I will put up soon... See you in class tomorrow!
Aswath Damodaran
adamodar@stern.nyu.edu
March 25, 2008
Hi!
What a week it has been for markets and investment banks? I know that the events
in the last few weeks have shaken quite a few of you up, especially if you
plan to work in financial markets and particularly in investment banks. I thought
I should put down my thoughts on what is happening, why it is happening and
what is coming next. Note, though, that these are my views and should not be
taken for more than what they really are - opinions. So, here goes:
1. What is happening?
This fiasco started late last summer as the sub-prime crisis. Initially, the
blame was placed almost entirely on those who had lent money to individuals with
bad credit histories at rates that were too low and the securities that were
built on those loans (mostly mortgage backed securities). Since then, it has
spread to other investors (hedge funds and private equity) and investments (high
yield bonds, equity in levered companies) and those who provide them credit (Countrywide,
CIT iand Bear Stearns). With all the blame being spread around, I think we need
to identify the true source of all of these problems and I think I have a candidate.
It is is what I call the "multiplier effect" of leverage. It begins
with a risky asset (say, a house or a operating business) that is funded with
too much debt. That debt is then packaged and sold as securities to investors
(insurance companies, pension funds,) who are attracted by the higher (but not
high enough) interest rates and their purchases are, in turn, funded with borrowings
of their own. The net effect is that the consolidated debt ratio for risky assets
became too high. At the household level, this manifested itself in loans that
were 85 or 90% (or even higher) of the estimated market value of the house at
the time of the purchase. At the portfolio manager level, it showed up (especially
in private equity and hedge funds) as extraordinary leverage (in levered beta
terms, these portfolios had monstrous exposures for equity invstors). In fact,
corporations and businesses were a lot more cautious in borrowing than investors
were, with market debt ratios at non-financial service firms remaining relatively
stagnant.
While high debt ratios by themselves are not deadly, they cannot be sustained
if the underlying asset values are volatile. Thus, when asset values (houses,
equities) decrease, they create a ripple effect. The borrowers (homeowners, hedge
funds) very quickly find that the equity in these assets is wiped out and the
lenders (commercial banks, investment banks) find that increasing proportions
of their loans are non-performing. The billions in dollars (euros) in write offs
at banks is a reflection of this reality. Since many of these loans have been
packaged and sold as securities to investors (pension funds, insurance companies,
individual investors), the pain is felt across the board.
What about commodity prices and the dollar? Here is where the Fed comes in. In
its attempt to keep financial institutions afloat and the economy from spiraling
further into a downturn, the Fed has been supplying liquidity to the market at
unprecedented levels. The best indicator of this is at the very short end of
the treasury yield curve, where 3-month yields hit historic lows. The decline
in interest rates and the flood of dollars hitting the market have put pressure
on the dollar to move lower. Since most commodities are priced in dollars, the
prices of commodities have increased to reflect the lower value of the dollar.
As evidence, note that the correlation between the dollar and commodity prices
over the last year have increased (it is a strong negative correlation - as the
dollar gets weaker, commodity prices increase.
I have attached a flow chart indicating the spiral that I have just described.
2. Why it is happening?
So, why did investors borrow too much money? The answer is simplistic but revealing.
It is because they thought that asset prices would keep going up (and that corrections
if they occurred would be mild) and lenders who were willing to lend them money
at interest rates that were too low (given the expected default risk). In other
words, both borrowers and lenders were too upbeat about the future. There are
institutional changes that added to the problem. The first is the growth of hedge
funds and private equity investors who are relatively unconstrained when it comes
to borrowing and investing. (Mutual funds, for instance, are much more constrained
in how much they can borrow). The second is the increasing securitization of
debt has made it easier to add layers of debt on top of each other in such a
way that no individual lender is aware of the risks building up but collectively
they are exposed.
3. What will happen next?
There is a disaster scenario, where the spiral continues and feeds on itself
- housing prices fall, defaults rise, economy slows, housing prices fall further....
but I think it is unlikely to occur The most likely scenario is that the spiral
will break and the process will right itself. In fact, there are internal contradictions
in this market that have to be resolved one way or the other. Consider, for instance,
the fact that gold prices have increased because investors are worried about
higher inflation in the future. This is contradicted by the fact that treasury
bond rates have come down - if inflation were as big a worry as the gold market
investors claim, treasury bond rates should have increased. Oil and commodity
prices are going up because the demand for them is supposedly spiking; at the
same time, though, there are others who are warning us that we are going to a
severe recession (where the demand for commodities will decrease). In other words,
one or the other of these fears will have to come to fruition but they cannot
all be true. In other words, we cannot be in a hyper-inflationary, slow-growth
economy with low interest rates and high commodity prices. (We will in hindsight
be able to point to the day when the spiral broke but only in hindsight. There
are some who are already pointing to the the Bear-Stearns/ Morgan deal as the
straw that broke the back of these contradictions, but it is still a little early
to be making that judgment... Suffice to say that we are in for some very interesting
times...)
4. Has it happened before?
It remains an enduring truth in markets that everything that is happening now
has happened before, albeit with slight variations. In fact, you can find parallels
to the the 1970s (high oil prices, high inflation), the 1980s (bad real estate
loans), the 1990s in Japan and 2001..... which is what makes it so difficult
to decide which way we will go next.
5. How can we stop it from happening again?
Notwithstanding all the talk about regulation and learning our lessons, I am
convinced that this is part of how markets work. Over-optimism and greed have
fueled bubbles for hundreds of years, followed by regret and promises that it
will never happen again. At the risk of being labeled insensitive, I am not sure
that it is a bad thing. Bubbles, after all, are a reflection of that optimism
that has always fueled progress for humans. A world run by actuaries (who look
at everything with a calculating eye and never over reach) would not only be
an exceptionally boring place but also would never see the advances that we have
seen.
6. How will if affect me?
After all, as self-interested beings, this is the key question. There is of course
the cliche that every threat is an opportunity, but here is what I think. The
ranks above you have been thinned out by the fall out from this crisis, which
should make it easier for you to shot up to the top. However, investment banks
are notoriously manic-depressive when it comes to hiring and firing and this
crisis has hit home. I believe that we are in for a period of consolidation with
little growth in investment banking ranks (I am including traders, investment
bankers and sales people in this group_ for the next couple of years. The pain
will be spread unevenly, with some areas of investment banking (mortgage backed
securities, real estate etc.) facing decimation and others still growing. If
you are in this game for the long term, it is better to have a skill set that
is general as opposed to one that is specific to a security or market. In other
words, knowing how to value a stock, bond or an option or how to determine the
optimal financing mix for a company is a far more durable skill than knowing
the institutional details of mezzanine financing... You may make more money in
the short term with the latter, but your long term survival is at far greater
risk.
Hope I have not depressed you too much on this bright, sunny day. If I have, try this link: http://www.youtube.com/watch?v=Nnjkb4q6FKU... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 27, 2008
Hi!
I know that you are in no mood for weekly challenges but these might actually
be useful for the next quiz... They cover two topics - the value of management
options and the circular reasoning embedded in every DCF valuation:
Give them a shot when you get a chance. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
March 29, 2008
Latest weekly newsletter attached. Solutions to weekly challenges are now up.
Aswath Damodaran
adamodar@stern.nyu.edu
April 1, 2008
Hi!
The quizzes are done and can be picked up in the usual spot. I am attaching the
solution and the distribution.... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 4, 2008
Hi!
I know that this is probably putting salt on the raw wounds left by the quiz,
but the mystery project is available to download.
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/MystProject.htm
The bad news is that it is due j two weeks from today (on April 18) . The good
news is that it is really not very involved: my estimate is that 4-5 hours should
get you to the analysis (and it is a group project with one analysis per group).
I have attached both the description for the project and the dataset to go with
it. You can also get it online on the course website (under mystery project).
It is pretty much self-explanatory... Please take a look at it when you get a
chance.
Aswath Damodaran
adamodar@stern.nyu.edu
April 5, 2008
Hi!
Newsletter for this week is attached..
Also, in advance of next week's class, where we will talk about PEG ratios,
I thought you might find this description in Wikipedia (Yes, Wikipedia) interesting:
http://en.wikipedia.org/wiki/PEG_ratio
If you have the time to keep reading, go to the Motley Fool article (Motley
Fool is one of my favorite investment sites... and I do write on occasion for
them...)
http://www.fool.com/investing/value/2006/04/06/how-useful-is-the-peg-ratio.aspx
As icing on the cake, you may want to read this equity research report from
UBS... Actually, it is quite well written but It has one very serious flaw
running all the way through it.... Let's see if you can spot it (As a clue,
look at the PE ratio equation on page 39...)
http://pages.stern.nyu.edu/~ekerschn/pdfs/readingsemk/EMK%20NYU%20S07%20Global%20Tech%20Strategy%20Special%20Edition%20Valuation.pdf
Until next time!
Aswath Damodaran
April 8, 2008
Hi!
I had promised an alternate mystery project for those of you interested in financial
service companies and I am attaching the dataset you will need. You will be
doing exactly the same things you are doing on the mystery project - finding
under and over valued companies - but doing so with banks.
On a different note, we will move on from earnings multiples to book value multiples tomorrow! Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 10, 2008
I know that time seems to be compressing as you approach graduation... If you do have a chance, give the weekly challenge for this week a quick look. It should not take you more than a few minutes....
We will also be completing packet 2 next week and starting on the third and
final packet. You can download the packet online and print it off right now.
You can get to the packet by going to the webcast page:
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/webcasteqspr08.htm
A couple of final notes. The first relates to cross holdings and EV/EBITDA
multiples. Bo Liang asked me to clarify what to add and subtract to make EV
multiples consistent. I am afraid that if I try to do that in an email, I will
end up completely confusing you. My suggestion is that you look at illustration
18.14 in the Investment Valuation book.... It should help (I hope) The other
relates to the early final. I am trying for the afternoon of May 6 (which is
the day after your last class). I will try to get a large enough room that
you can decide at a fairly late stage as to whether you want to take the early
exam or not... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 12, 2008
Hi!
Too nice a weekend to be working on the mystery project, right? Anyway, I am
attaching the newsletter for this week.. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 15, 2008
Hi!
As we approach the end of the relative valuation section, i have a few "highlights" I
want to emphasize:
a. Philosophy: Philosophically, do not lose sight of the question that you are
trying to answer in relative valuation, as opposed to discounted cash flow valuation.
While the latter is about making a judgment on whether something is under or
over valued, given its intrinsic value, relative valuation is about making relative
judgments. Thus, it is entirely possible to finding something under valued on
a DCF basis and overvalued on a relative basis or vice verse at the same time.
b. Equity versus Firm value multiples: The key to using multiples well is to
first focus on whether you are working with an equity multiples (PE, Price to
book...) or a firm value multiple (EV./EBITDA, EV/Invested Capital) and recognizing
the fundamentals that you have to control for. The latter is almost always an
algebraic problem which can be solved by reverting to an equity DCF model (try
the stable growth DDM) for equity multiples and and a firm valuation model for
firm multiples.
c. Regressions are useful tools for controlling for differences but they are
tools.
I hope that working with the mystery project will give you some insight on both
the pluses and minuses of multiples.
As for the mystery project, I want to reemphasize a few points I made in class
this morning:
1. This is a relative valuation and not an intrinsic valuation exercise. While
I understand the impulse to estimate the intrinsic value of each of these companies,
there are too many missing pieces (cost of debt, maturity of debt etc.) for you
to to do this in a meaningful way. So, don't fight the data.....
2. Don't lose sight of the ultimate objective, which is to find under and over
valued firms.....
3. The final project report is due on Friday by 5 pm. It can be electronically
submitted (and no hard copy is necessary)... Please turn in one report per group.
Finally, to brand name valuation. We did talk about brand name valuation in class
this morning. If you are interested in this topic, you may want to read the paper
I have on valuing intangible assets on my website (I am attaching a pdf version).
It looks at brand name valuation....
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 16, 2008
Hi!
I hope you are almost done with the mystery project or well on your way there...
Here are a few final thoughts:
1. Deadline: The deadline for the mystery project is 5 pm on Friday
2. Format: Your basic task is pretty clear - find the most under and over valued
companies - and pick a company as a "private equity" investor. Tell
me what multiple or multiples you used, why you picked it or them and how you
used them to come to your conclusion. Please, please be brief...
3. Submission: Please submit your report electronically, either as a word file
or a pdf file with the subject: Mystery project submission. Repress the urge
to add exhibits that you do not reference or graphs for the sake of graphs...
A final thought. Don't get sucked into the numbers.. maintain some objectivity...
and relax... Your money is not riding on your findings..... Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 16, 2008
Hi!
I completely forgot to mention quiz 3 in my earlier email and I am sorry. The
quiz will be on Monday from 1.30-2 and will cover everything we covered since
the second quiz, which is all of packet 2. In particular, the quiz will cover
relative valuation and private company valuation. The past quizzes are a bit
of a mixed bag. The last three quiz 3s are good indicators of what will be
on this quiz. Prior to that, though, you may want to look at a mix of quiz
2s (for relative valuation) and quiz 3 (for private company valuation). As
for chapters in the investment valuation book, the relevant chapters are 17-20
and 24.... Hope that helps!
Aswath Damodaran
adamodar@stern.nyu.edu
April 17, 2008
Hi!
I know that you are working on the last touches to the mystery project ( I hope)
but this is completely unrelated. I had promised an early final for those who
needed to get done soon. The early final is scheduled from 10-12 on May 6 in
KMEC 2-65. Please let me know at least a week before the exam whether you will
be taking it... If not, I will see you on May 12 (which is the regularly scheduled
day).
Aswath Damodaran
adamodar@stern.nyu.edu
Apri 17, 2008
Hi!
For those of you who are thinking about private company valuations and baseball
at the same time, here is something that should bring the two together:
http://www.forbes.com/lists/2008/33/biz_baseball08_The-Business-Of-Baseball_Rank.html?boxes=custom
Aswath Damodaran
adamodar@stern.nyu.edu
April 17, 2008
For those of you who are soccer fans and feel left out:
http://www.forbes.com/lists/2007/34/biz_07soccer_Soccer-Team-Valuations_MetroArea.html
Aswath Damodaran
adamodar@stern.nyu.edu
April 18, 2008
Hi!
First things first. Thank you for getting your mystery projects to me today.
I think I have graded and returned all of them. I tried to reply all when I
sent the projects back to make sure that everyone in the group got a copy.
If you did send me your report and you have not heard from me, please do let
me know. I will check through my emails in the last couple of days. In terms
of what you used to analyze the companies and what you found:
a. Multiple used; Of the 22 project reports, 12 used PE ratios, 7 used PBV (including
all four groups that did the bank dataset), 3 used EV/EBITDA and a couple used
revenue multiples.
b. Most undervalued companies: The companies that came out as undervalued most
often across groups were as follows:
Unitedhealth 9
Goldman 12
CVRD 7
Daimler 14
Honda 8
c. Most overvalued companies: The companies that came out as overvalued most
often across groups were as follows:
Deutsche Telecom 8
Monsanto 9
Mosaic 7
Potash 15
RIMM 18
I think I will get rid of my Blackberry...
: United Health Care was the most commonly chosen LBO target. There were a couple
of surprises. Two people picked Goldman as their target (Now that would be an
LBO to watch.. Talk about sauce for the goose)... Two picked Google (That one
I would like to watch from the sidelines). Just a note though. Most of you recognized
the need to pick companies with debt capacity but relatively few groups focused
on operating inefficiencies. In other words, you want to buy an under levered,
poorly performing (managed) company as your target since debt is part of the
story but the restructuring is the other half...
Second, the third quiz is on Monday. Doing the mystery project was a good preparation...
It will cover packet 2... I know, I know.. That is a lot of stuff... but you
know your stuff now...
Third and finally, I have attached the newsletter for this week (which no one
reads any more...) Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 22, 2008
Hi!
The quizzes are done and can be picked up in the usual spot. I have attached
the solution and attempted to attach the distribution. Let's see if it comes
through this time.
Aswath Damodaran
adamodar@stern.nyu.edu
April 23, 2008
H!
I hope you have had a chance to pick up your quiz and that it contained good
news... There are two notes that I want to draw your attention to:
1. Project: Your final project, which may have been on mothballs for a few weeks,
needs to be completed. In particular, you have to do a relative valuation (using
a multiple and comparable firms) for your company.If you have not started on
the relative valuation of your company, please do. Start off by comparing your
firm's multiple (PE, PBV or whatever) to the average for the sector and try some
story telling... the more creative, the better). Then, try some statistical solutions.
If you are getting bogged down in the regression that you may be running across
your comparable firms, here is some advice:
a. If you get a low R-squared, try some creative fixes. You can use forward multiples
(see Global Crossing analysis in lecture notes) or proxies for survival and profitability
(see internet company regression on package).
b. If you still get a low R-squared, go ahead and use the regression anyway to
make your forecast for your company. Remember that you getto decide how much
you will use this value in making your final recommendation. Based upon the low
R-squared, you may decide to weight it very little or not at all.
c. When you run your multiple regression, don't get carried away. The number
of independent variables should generally depend upon thenumber of firms in your
sample. If you have between 10-20 firms, useonly one independent variable. You
can add an extra independent variable (though you don't have to) for every additional
10 firms in your sample.
d. Keep your eyes on what your final recommendation is going to be.
Everything you do is feeding into that decision.
2. Early final exam: For those of you who cannot wait until May 12 to take your
final, here is a solution. There will be an early final on May 6 from 10-12...
... it will be different from the May 12 final and I cannot promise you that
the level of difficulty will be the same (but read no implied messages into this
statement).
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 24, 2008
Hi!
I hope you have had a chance to pick up your quiz and that it contained good
news... There are two notes that I want to draw your attention to:
1. Project : Your final project, which may have been on mothballs for a few
weeks, needs to be completed. In particular, you have to do a relative valuation
(using a multiple and comparable firms) for your company.If you have not started
on the relative valuation of your company, please do. Start off by comparing
your firm's multiple (PE, PBV or whatever) to the average for the sector and
try some story telling... the more creative, the better). Then, try some statistical
solutions. If you are getting bogged down in the regression that you may be
running across your comparable firms, here is some advice:
a. If you get a low R-squared, try some creative fixes. You can use forward
multiples (see Global Crossing analysis in lecture notes) or proxies for survival
and profitability (see internet company regression on package).
b. If you still get a low R-squared, go ahead and use the regression anyway
to make your forecast for your company. Remember that you getto decide how
much you will use this value in making your final recommendation. Based upon
the low R-squared, you may decide to weight it very little or not at all.
c. When you run your multiple regression, don't get carried away. The number
of independent variables should generally depend upon thenumber of firms in
your sample. If you have between 10-20 firms, useonly one independent variable.
You can add an extra independent variable (though you don't have to) for every
additional 10 firms in your sample.
d. Keep your eyes on what your final recommendation is going to be.
Everything you do is feeding into that decision.
2. Early final exam : For those of you who cannot wait until May 12 to take
your final, here is a solution. There will be an early final on May 6 from
10-12... ... it will be different from the May 12 final and I cannot promise
you that the level of difficulty will be the same (but read no implied messages
into this statement).
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 26, 2008
Hi!
Just a quick note. The newsletter is up and running... It is attached.
Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 26, 2008
Hi!
I hope that the discussion of using option pricing to explain the value of financial
flexibility and equity value in troubled firms at least got you thinking...
Anyway, both Elias and Uri asked me questions about what it is about equity
in a debt-laden firm that gives it the characteristics of an option and I don't
think I did a good job of explaining my rationale. So, let me try again. Assume
that you and i both have $ 250,000 and go to Atlantic City. You gamble on your
own wealth but the casino decides to lend me $750,000 with no backing. We both
have 24 hours to gamble with the money we have and will keep gambling until
our money runs out. We both start at the high stakes tables (think Casino Royale....)
You gamble until you lose your $250,000 and then you are done. I start at the
same tables, but I don't have to stop when I lose $ 250,000.... Since I have
a million dollars to play with, I can lose $ 500,000 in the first 2 hours and
still keep playing. In fact, once I lose $250,000, I have little incentive
to play it safe. I am technically bankrupt (and you cannot come after my personal
assets). I might as well keep taking bigger and bigger bets, hoping that one
of them bails me out. That, in effect, is where the option value comes form
- the fact that a firm value can drop below the outstanding debt and the equity
investors still get to play the game.
If you are one of those unlucky people who has been saddled with the money-losing
company, here is one more cross to bear. If your firm owes a lot (my rule of
thumb is a market debt to capital ratio that exceeds 40%), you can value the
equity in your firm as an option... Before you jump out of the window, let me
hasten to add that it is not as bad as it sounds. Here are the inputs you need
to the option pricing model:
1. S = Value that you attached to your firm (not equity) in your DCF valuation.
I would make this a conservative estimate (use low or no growth) to reflect the
fact this is liquidation value.
2. K = Face value of all of the outstanding interest- bearing debt in your firm.
If you can, add the expected coupon or interest payments to this number. Thus,
if you have a 10 year, 8% loan for $ 100 million, your face value would be 100
+ 10 * (.08*100) = 180 million
3. t = Weighted average duration of the debt ( I know... I know.. Duration is
a pain in the neck to estimate... You can use maturity) There should be a table
in your financial statements telling you how much debt comes due by year (there
will be a thereafter... just make that a year beyond your last year) Take a face-value
weighted average of when the debt comes due.
4. Standard deviation in firm value = Use the bottom up estimate for the sector
that you can download off my site. Go to updated data and look towards the bottom
of the page.
5. Riskfree rate - Find the treasury bond rate that corresponds to your option
life
If you want to download a spreadsheet that does the calculation for you, you
can find one under spreadsheets on my site.... I am also attaching it to this
email.
If you do not have a money losing, indebted firm, you do not have to do option
pricing....
Aswath Damodaran
adamodar@stern.nyu.edu
April 29, 2008
Hi!
I know that you are incredibly busy and have little time for other pursuits right
now. However, I would like to ask you two favors. The first is that you do
come to class (I do know that some of you have been in webcast mode for the
last few sessions) tomorrow and on Monday. The second is that you spend a little
time on the attached set of questions before class tomorrow! (The tests are
very simple and should not take your more than 20 minutes and are great feedback
on whether you really get valuation basics). Since you have been exceedingly
patient as we have gone through the fundamentals of valuation, these last two
sessions will give us a chance to test out how much has stuck. Tomorrow, we
will start with a series of tests on acquisition valuation and then look at
move on to look at the levers that can change the value of a company. Nothing
that we do will be new but it will help you understand the versatility of the
tool set that you have developed. Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
April 30, 2008
Now that the finish line beckons, here are a few loose ends to tie up.
1. Project due date and format: The project due date is next Monday, by the
end of the day. The submission should be electronic, with one submission
for the entire group. Please keep it brief and include only those exhibits
that are necessary to bolster your case. Keep additional attachments to a
minimum.
2. What should be included? Every project should include a DCF valuation and
a relative valuation for your company, together with a final recommendation
(buy, sell or hold). If your company has negative earnings and a debt to capital
ratio that exceeds 50%, you can try valuing it using an option pricing model
(see below, before your panic).
3. Option pricing model: If you have a negative earnings, highly levered company
(negative earnings alone will not do the trick), you can value the equity in
the company as an option. (Don't be surprised if no one in your group can do
this.. Works for only about 1 in 10 companies) While we will be covering this
in class on Monday, you can get a jump on the process by using the attached
spreadsheet. There are just a few inputs that you will need to complete this
(in case you are the unlucky soul with the qualifying company).
a. Value of the existing assets: Use the DCF value of the operating assets
of your company
b. Strike price; Use the face value of debt outstanding at the company (not
the market value)
c. Average maturity of the debt: Use the average maturity of the debt outstanding
d. Std deviation in the value of the existing assets: Use the sector std deviations
that are included in the option valuation spreadsheet for the sector that your
troubled company belongs to...
e. Riskfree rate: Enter the government bond rate corresponding to the maturity
of your debt
The value of equity as an option should show up as output.
4. What do you want in the summary sheet? The attached summary sheet asks for
basic information about the valuation of your company. I will use it to compile
the summary for the class. Please return it to me as soon as possible... I
would prefer one summary sheet per group but if you have someone holding you
up, I will settle for as many of your group numbers as you can get to me. Thank
you very much!
Aswath Damodaran
adamodar@stern.nyu.edu
May 2, 2008
Hi!
Hope that your valuations are moving along... Just a couple of loose ends from
prior classes.
a. Black Scholes guide: One relates to using the Black Scholes. For those of
you who have never done this before, I have put together a document on using
the Black Scholes. It is attached. Try it on one of the options that I have valued
in the packet and see if you get the same numbers... t will take a couple of
tries before you are comfortable with it.
b. Use of pre-tax cost of debt: There was a question about why I used the pre-tax
cost of debt of the licensors to discount after-tax licensing revenues for Biogen
during Wednesday's class. I said I would think about it and get back to you.
I have thought about it and I think the pre-tax cost of debt is the right cost
to use. In general, it is true that you use after-tax rates to discount after-tax
cash flows. In this case, though, this is not the cost of debt for Biogen. It
is the pre-tax cost of borrowing for the licensors who pay the fees. Consequently,
i think of it more as a risk adjusted discount rate rather than a cost of raising
funding. The risk that these licensing fees will not be delivered is captured
by this rate. Note that Biogen itself does not have any debt. Using an after-tax
cost of debt to discount these cash flows will only inflate their value to Biogen.
c. Early finals: If you are in the later early final on Tuesday, note that the
while the first early final is from 10-12 in KMEC 2-65. See you there!
Finally, if you have returned your summary sheets, many thanks! If you have not,
a preemptive thanks, because I know you will not let me down.... I wait with
bated breath!
Aswath Damodaran
adamodar@stern.nyu.edu
May 3, 2008
Hi!
Sorry for the email bombardment.. I do know that the fcffginzu.xls spreadsheet
that I emailed you as an attachment in the email last week has last year's
defaults spreads in the ratings worksheet built into it (which are lower than
this year's spreads..) Since most of you should have your pre-tax cost of debt
nailed down before you get to this spreadsheet, you probably have not noticed
it. In case you want to use the ratings spreadsheet in the valuation spreadsheet,
you have two choices. Download a fresh version of the fcffginzu.xls from the
website or update the spreads to match the numbers in the capstru.xls spreadsheet...
The latter is probably an easier option... (The industry averages in the fcffginzu.xls
spreadsheet are 2007 numbers and the new version online has the 2008 numbers.
If you have used the 2007 industry averages anywhere in your valuation, I would
leave it as is.. There is no reason to believe that the 2008 numbers are better
simply because they are more updated...)
Aswath Damodaran
adamodar@stern.nyu.edu
May 6, 2008
Hi!
The end is near... Repent, repent (Could not resist that). Anyway, for those
of you taking the early final today, good luck! I have put yesterday's closing
presentation online on the webcast page for the class as well as the full excel
file containing the recommendations. Take a look at it when you get a chance.
As an administrative detail, please do fill out the CFE for the class. If yo
do not, you will not be able to access your graded (the school's rule, not
mine..) Until next time!
Aswath Damodaran
adamodar@stern.nyu.edu
May 13, 2008
Hi!
This is it... The finals are outside my office in alphabetical order in a box
(Note that they are not in the usual spot since the corporate finance exams
have pretty much taken up all the space) and the grades are online. I have
attached the solutions to this email. Since many of you are graduating, this
will be my last email to you as Stern MBAs, I want to to wish you the very
best with whatever you plan to do with your lives. I mean it when I say that
you have my email address for life and can bounce off any questions, queries
or issues that you have with corporate finance, valuation or the most valuable
sports franchises in the world. I hope to see you at graduation and it has
been a pleasure teaching you for the last semester or two. Until next time!
(and that is not a threat of more emails...)
Aswath Damodaran
adamodar@stern.nyu.edu