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How did you learn Valuation?


DocSnowball
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Where did you learn valuation from and how? I've struggled in this area and am considering a semester long course through Professor Damodaran's online valuation course at NYU (link below).

http://www.stern.nyu.edu/programs-admissions/online-certificate-courses/online-valuation-course

 

Are you a storyteller (or even a quant) who struggled with valuation? How did you overcome your shortcomings in this area? Thanks in advance for sharing!

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How's your accounting? I took finance and accounting in college and find the accounting much more practical. In school they try to make valuation very scientific, but there's a lot of practical flaws with the way it's taught (beta as risk for example... it's very precise but not very accurate). At the end of the day it mostly comes down to a good understanding of the accounting, which is why I asked that first. There's a lot of much better investors here, but I end up just looking at equities similar to bonds... if the company generates $1 of cash flow per share, and the shares are $10, is a 10% yield right for the risk/reward? When I've been wrong it's usually because I misjudged something on the risk/reward side so a discounted cash flow model wouldn't have helped me because my inputs would have been wrong.

 

For what it's worth, this was the valuation textbook we used in school: https://smile.amazon.com/Valuation-Measuring-Managing-Companies-Finance/dp/111887370X/

This book I bought for interviewing.. kind of the cliff's notes but a pretty big book: https://smile.amazon.com/Practitioners-Investment-Acquisitions-Corporate-Scoopbooks/dp/0976154803?pldnSite=1&ref_=nav_signin&

 

Hope that's helpful.

 

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There's a lot of much better investors here, but I end up just looking at equities similar to bonds... if the company generates $1 of cash flow per share, and the shares are $10, is a 10% yield right for the risk/reward? When I've been wrong it's usually because I misjudged something on the risk/reward side so a discounted cash flow model wouldn't have helped me because my inputs would have been wrong.

This is also my understanding. My valuation process isn't very scientific but mistakes come from misunderstsnding the business instead of valuation. As such it is important to understand the accounting and the business. I've been trying (without success) to find books about business models (example: how a construction/retail/oil/bank/restaurant company makes money and how to measure it) because that is where money is made.

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How's your accounting? I took finance and accounting in college and find the accounting much more practical. In school they try to make valuation very scientific, but there's a lot of practical flaws with the way it's taught (beta as risk for example... it's very precise but not very accurate). At the end of the day it mostly comes down to a good understanding of the accounting, which is why I asked that first. There's a lot of much better investors here, but I end up just looking at equities similar to bonds... if the company generates $1 of cash flow per share, and the shares are $10, is a 10% yield right for the risk/reward? When I've been wrong it's usually because I misjudged something on the risk/reward side so a discounted cash flow model wouldn't have helped me because my inputs would have been wrong.

 

For what it's worth, this was the valuation textbook we used in school: https://smile.amazon.com/Valuation-Measuring-Managing-Companies-Finance/dp/111887370X/

This book I bought for interviewing.. kind of the cliff's notes but a pretty big book: https://smile.amazon.com/Practitioners-Investment-Acquisitions-Corporate-Scoopbooks/dp/0976154803?pldnSite=1&ref_=nav_signin&

 

Hope that's helpful.

 

Thanks so much for sharing! Love your bond model, very easy to understand in a mature company.

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There's a lot of much better investors here, but I end up just looking at equities similar to bonds... if the company generates $1 of cash flow per share, and the shares are $10, is a 10% yield right for the risk/reward? When I've been wrong it's usually because I misjudged something on the risk/reward side so a discounted cash flow model wouldn't have helped me because my inputs would have been wrong.

This is also my understanding. My valuation process isn't very scientific but mistakes come from misunderstsnding the business instead of valuation. As such it is important to understand the accounting and the business. I've been trying (without success) to find books about business models (example: how a construction/retail/oil/bank/restaurant company makes money and how to measure it) because that is where money is made.

 

We just studied this in Strategy class taught by the same professor who teaches Value investing, so I’m much more comfortable with this part. The problem is without a strong handle on valuation I wonder if I’m understanding the story or telling myself a fairytale...

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There are two kinds of valuation - qualitative and quantitative. Too many people focus on the quantitative valuation and then wonder what happened when the perfectly beautiful numbers blindsighted them to competitive problems - or management problems.

 

Thanks so much - yes, this is very much what I’m trying to learn especially in biotech. Because a lot of the valuation is based on projections of trial success or peak sales into the future, and then handicapping those projections based on risk of failure of the drug or company, or of its marketing.

 

Do you all have suggestions on how exactly you crystallize your qualitative back of the envelope thinking into a written document- how do you make it play out and put it together so that you can keep going back to it as fundamentals change or play out to see what range of projections you’re seeing play out?

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There are two kinds of valuation - qualitative and quantitative. Too many people focus on the quantitative valuation and then wonder what happened when the perfectly beautiful numbers blindsighted them to competitive problems - or management problems.

 

+1. Qualitative factors are huge, but the books that helped me the most on valuation are McKinsey's two books Valuation (aptly named) and Creative Cash Flow Reporting. I've read the second one twice and have a combined 28 pages of notes I've taken from both books that I still refer to on a semi-regular basis. They're more textbooks than anything (i.e. dry, slow reads), but I can't recommend them enough.

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The best way to learn valuation is to read all the basic financial statements (balance,cashflow etc) for a company and then guess the price.

 

I would add in some qualitative research.

 

My best education was reading 10ks and doing some light qualitative research, then writing my price on the 10k cover, then compare to the market cap. Do that 20 times and you will learn.

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The best way to learn valuation is to read all the basic financial statements (balance,cashflow etc) for a company and then guess the price.

 

I would add in some qualitative research.

 

My best education was reading 10ks and doing some light qualitative research, then writing my price on the 10k cover, then compare to the market cap. Do that 20 times and you will learn.

 

Thank you both. If I can ask you a bit more, can you share how your valuation skills evolved from #1 to #20 to now? Would love to know the evolution!

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Hard question to answer. If I had to guess, it would be I realized more and more what DROVE the valuation. What factors to focus on/are most important.

 

One of the best exercises I did was the following:

 

I would first read the annual report, look thru 10 years or so of financials, do whatever qualitative research, and then after all that, I would essentially have a mock negotiation. I would try and imagine two warren buffett's, one who owned the company and the other who was trying to buy the company. So two parties who were equally shrewd, already super duper rich, and each knowing as much information as the other. What would the transaction price be between those two?

 

And I would pretty much write out a conversation where it started by the buyer offering $1 and the seller offering $1 trillion (or something equally absurd). And just triangulate some value from there.

 

So like, the buyer would say 'well you've got 20B of debt therefore..." and the seller would go "well it just made 100M of FCF so..."

 

Maybe it sounds silly but I'll tell you it worked really well.

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I would recommend reading 'Financial Shenanigans', pares well with the aforementioned 'Creative Cash Flow Reporting'. I would also be focused on frauds or perhaps follow investors that are predominantly short. They have to have an astute knowledge of accounting which in my mind is the most important factor. Their thesis is also much less influenced by random events and needs to be much more precise than on the long side. They also frequently point to errors in other valuations which is always the best way to learn.

 

It is also fun. Through doing this I learned about accretable yield, one of the more insane ways to perform accounting for loans - http://soberlook.com/2009/05/accretable-yield-accounting-magic.html

 

Theoretical valuation is a tricky thing. I despise DCF models that have terminal value assumption. This is akin to forecasting the end of the world and it is clearly insane. I would also note that while we have all the McKinsey books etc., individual players in the financial markets sometimes completely disregard this 'teaching'. Just look at the sell-side research. This then prompts questions about the value of such theory.

 

The situation is similar to Economics. In finance, there is no law of gravity, no holy truth that works because finance is about people that often make irrational decisions that are hardly predictable. Thus any attempt to present a holy truth (DCF model) is bound to fail.

 

I understand that 'rigorous' valuation (for example of Mr. Damodaran) can help sometimes to at least try to get a sense of the situation, but the obsession with models is something that one should be aware of. Read Taleb for fun arguments about this.

 

But don't mind me. I am focused on nano-caps and OTC where I am looking to buy 'a house for the price of the bricks' and do not care where the S&P 500 will be or whether AMZN is going to devour retail, so I have my own set of strong biases about the financial education.

 

P.S. I would recommend having a peek on the 6th version of Security Analysis. 

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Hard question to answer. If I had to guess, it would be I realized more and more what DROVE the valuation. What factors to focus on/are most important.

 

Thanks a lot to all of you for contributing - then these are the main objectives for me. 1) Reading the annual reports, earnings calls, and financial statements and translating them into projected earnings, as well as assets and liabilities. 2) Estimate a lowball and high end range of market cap valuation 3) Understanding what material factors I think are driving and will drive the valuation going forward, and tracking them over time.

 

I'd like to develop this level of understanding in my field of biotech and healthcare (which interestingly a lot of investors shy away from because of risks that cannot be foreseen, but this also brings a lot of mispriced opportunities). 

 

Just ordered the books and will try to work on a couple of companies this semester. Will try to open up my first thread in Investment ideas with this!

Thanks again

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In terms of earnings calls (aka mgmt commentary) - I only found these useful once I already had my own opinion about the business. When you don't really know anything, it is tempting to read mgmt's comments and simply adopt their view. It is more useful to first establish your own opinion and then compare/contrast your perspective with mgmt's perspective. One thing I would note is the question, "what does management think is important, and why? does it agree with what I think is important? why or why not?"

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@LC thank you that is a great point

 

I just went through the primer on financial statements and found it helpful. The little summary is helpful to add to the objectives:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/accstate.htm

 

When doing a financial analysis of a firm, we would like to be able to answer the following questions —

 

What are the assets that the firm has in place already, and how much are they worth? How risky are these assets?

What are the growth assets of the firm and what is their value? How risky are these assets?

What is the firm earning on its assets in place, and what can it expect to earn on these same assets as well as its growth assets?

What is the mix of debt and equity that the firm is using to finance these assets?

How risky is the debt? How risky is the equity?

 

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  • 3 months later...

Circling back - thank you to all those who commented in the past. 

 

I’m almost done with Professor Damodaran’s Valuation course, and as a non finance person (of the storyteller kind), have found it really really helpful to become more disciplined in my storytelling.

 

In the same vein as the comments, having a coherent model helps one of identify the key drivers of intrinsic valuation. Just lays it out to crystallize thinking and minimize biases. Having anarrative laid out helps to see going forward how the story is unfolding vis-a-vis the intrinsic valuation

 

Finally, this great post and the model I used to valuea young growth small biotech Achaogen was very eye opening when looking at young growth companies - perhaps one of the hardest areas to value!

 

http://aswathdamodaran.blogspot.com/2013/09/many-slip-between-cup-lip-from-forward.html

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Go buy a financial or intermediate accounting textbook (financial is the intro class, intermediate is the advanced) and read through those. Or find a local community college and take an online accounting class. Those accounting textbooks and corresponding class take you line by line through the financial statements. Granted, by reading 10-Ks, annual letters, and even Buffett's letters over a long period of time you can pick up a lot too.

 

I've got an intermediate final exam tomorrow and I'm so glad I took accounting, I don't think there's a business major that is as in-depth and valuable as accounting.

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