In the past few months I have been studying the art and science of financial valuations, picking up key skills required for evaluating the performance of a company. I am penning this brief piece down to make a note of important pointers which serve as a reminder for myself and may also help anyone reading this. Most of the pointers are from various freely available talks and videos by Prof. Aswath Damodaran, Professor of Finance at NYU, widely regarded as one of the foremost practitioners and teachers of valuation globally.
In no specific order, I have made a list of some important takeaways from his talks :
- “Fundamentally valuations are easy and anyone can do them, they are mostly just overlayed with complex jargon and dressed up because that is how investment bankers keep the process opaque and make money.” (This is true for many professions.)
2. Four important questions to consider while doing a valuation :
A. What are the cash flows from existing assets?
B. How much cash flow would future growth bring in? (What is the value of future growth — This is primarily done via a Discounted Cash Flow analysis — The current value of your business is the present value of the expected cash flows from running the business.)
C. How risky are the cash flows?
D. When will you become a mature company?
3. Aswath Damodaran also categorizes people into two broad groups — ‘Story people’ and ‘Numbers people’ — Story people say that valuation is all about the narrative, the numbers do not matter much.
The numbers people say that they don’t understand stories or why they are important, and that numbers are core to valuations.
He goes onto say that the magic is somewhere in between. Stories are actually more important in the Venture Capital business, the numbers are negotiation tactics, but it helps a lot to get a hold of the numbers.
4. Difference between Pricing and Valuing. (A lot many times ‘pricing’ is passed off as ‘valuing’) — Price is set by ‘Demand’ and ‘Supply’. It varies based on ‘Mood’ and ‘Momentum’. Valuation is set by estimating and evaluating Cash flows, Growth, and Risk.
This 4th pointer is very interesting, it is something to keep in mind when we hear about startups hitting ‘Unicorn’($1B) or ‘Decacorn’($10B) valuations. A lot many times VC’s pay a ‘price’ based on competing offers to clinch a deal, they put forth the best offer, and we end up reading media articles which call these ‘prices’ crazy ‘valuations’.
(I will keep adding to this piece periodically)