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AswaLh uamodaran
hup://www.damodaran.com
Aswath Damodaran 1
2
lnLrlnslc value: 1hree 8aslc roposluons
! 1he value of an asseL ls Lhe presenL value of Lhe expecLed cash
ows on LhaL asseL, over lLs expecLed llfe:
! roposluon 1: lf lL" does noL aecL Lhe cash ows or alLer rlsk
(Lhus changlng dlscounL raLes), lL" cannoL aecL value.
! roposluon 2: lor an asseL Lo have value, Lhe expecLed cash ows
have Lo be posluve some ume over Lhe llfe of Lhe asseL.
! roposluon 3: AsseLs LhaL generaLe cash ows early ln Lhelr llfe wlll
be worLh more Lhan asseLs LhaL generaLe cash ows laLer, Lhe
lauer may however have greaLer growLh and hlgher cash ows Lo
compensaLe.
Aswath Damodaran
2
3
1he fundamenLal deLermlnanLs of value.
What are the
cashows from
existing assets?
- Equity: Cashows
after debt payments
- Firm: Cashows
before debt payments
What is the value added by growth assets?
Equity: Growth in equity earnings/ cashows
Firm: Growth in operating earnings/
cashows
How risky are the cash ows from both
existing assets and growth assets?
Equity: Risk in equity in the company
Firm: Risk in the rms operations
When will the rm
become a mature
irm, and what are
the potential
roadblocks?
Aswath Damodaran
3
Current Cashow to Firm
EBIT(1-t)= 5344 (1-.35)= 3474
- Nt CpX= 350
- Chg WC 691
= FCFF 2433
Reinvestment Rate = 1041/3474
=29.97%
Return on capital = 25.19%
Expected Growth in
EBIT (1-t)
.30*.25=.075
7.5%
Stable Growth
g = 3%; Beta = 1.10;
Debt Ratio= 20%; Tax rate=35%
Cost of capital = 6.76%
ROC= 6.76%;
Reinvestment Rate=3/6.76=44%
Terminal Value
5
= 2645/(.0676-.03) = 70,409
Cost of Equity
8.32%
Cost of Debt
(3.72%+.75%)(1-.35)
= 2.91%
Weights
E = 92% D = 8%
Op. Assets 60607
+ Cash: 3253
- Debt 4920
=Equity 58400
Value/Share $ 83.55
Riskfree Rate:
Riskfree rate = 3.72%
+
Beta
1.15
X
Risk Premium
4%
Unlevered Beta for
Sectors: 1.09
3M: A Pre-crisis valuation
Reinvestment Rate
30%
Return on Capital
25%
Term Yr
$4,758
$2,113
$2,645
On September 12,
2008, 3M was
trading at $70/share
First 5 years
D/E=8.8%
Cost of capital = 8.32% (0.92) + 2.91% (0.08) = 7.88%
Year 1 2 3 4 5
EBIT (1-t) $3,734 $4,014 $4,279 $4,485 $4,619
- Reinvestment $1,120 $1,204 $1,312 $1,435 $1,540 ,
= FCFF $2,614 $2,810 $2,967 $3,049 $3,079
Aswath Damodaran 4
Current Cashflow to Firm
EBIT(1-t) : Rs 20,116
- Nt CpX Rs 31,590
- Chg WC Rs 2,732
= FCFF - Rs 14,205
Reinv Rate = (31590+2732)/20116 =
170.61%; Tax rate = 21.00%
Return on capital = 17.16%
Expected Growth
from new inv.
.70*.1716=0.1201
Stable Growth
g = 5%; Beta = 1.00
Country Premium= 3%
Cost of capital = 10.39%
Tax rate = 33.99%
ROC= 10.39%;
Reinvestment Rate=g/ROC
=5/ 10.39= 48.11%
Terminal Value
5
= 23493/(.1039-.05) = Rs 435,686
Cost of Equity
14.00%
Cost of Debt
(5%+ 4.25%+3)(1-.3399)
= 8.09%
Weights
E = 74.7% D = 25.3%
Discount at Cost of Capital (WACC) = 14.00% (.747) + 8.09% (0.253) = 12.50%
Op. Assets Rs210,813
+ Cash: 11418
+ Other NO 140576
- Debt 109198
=Equity 253,628
Value/Share Rs 614
Riskfree Rate:
Rs Riskfree Rate= 5%
+
Beta
1.20
X
Mature market
premium
4.5%
Unlevered Beta for
Sectors: 1.04
Firm!s D/E
Ratio: 33%
Tata Motors: April 2010
Reinvestment Rate
70%
Return on Capital
17.16%
45278
21785
23493
+ Lambda
0.80
X
Country Equity Risk
Premium
4.50%
Country Default
Spread
3%
X
Rel Equity
Mkt Vol
1.50
On April 1, 2010
Tata Motors price = Rs 781
Rs Cashflows
Average reinvestment rate
from 2005-09: 179.59%;
without acquisitions: 70%
Growth declines to 5%
and cost of capital
moves to stable period
level.
Year 1 2 3 4 5 6 7 8 9 10
EBIT (1-t) 22533 25240 28272 31668 35472 39236 42848 46192 49150 51607
- Reinvestment 15773 17668 19790 22168 24830 25242 25138 24482 23264 21503
FCFF 6760 7572 8482 9500 10642 13994 17711 21710 25886 30104
Aswath Damodaran 5
Aswath Damodaran 6
Forever
Terminal Value= 1881/(.0961-.06)
=52,148
Cost of Equity
12.90%
Cost of Debt
6.5%+1.5%=8.0%
Tax rate = 0% -> 35%
Weights
Debt= 1.2% -> 15%
Value of Op Assets $ 15,170
+ Cash $ 26
= Value of Firm $14,936
- Value of Debt $ 349
= Value of Equity $14,847
- Equity Options $ 2,892
Value per share $ 35.08
Riskfree Rate:
T. Bond rate = 6.5%
+
Beta
1.60 -> 1.00
X Risk Premium
4%
Internet/
Retail
Operating
Leverage
Current D/
E: 1.21%
Base Equity
Premium
Country Risk
Premium
Current
Revenue
$ 1,117
Current
Margin:
-36.71%
Sales Turnover
Ratio: 3.00
Competitive
Advantages
Revenue
Growth:
42%
Expected
Margin:
-> 10.00%
Stable Growth
Stable
Revenue
Growth: 6%
Stable
Operating
Margin:
10.00%
Stable
ROC=20%
Reinvest 30%
of EBIT(1-t)
EBIT
-410m
NOL:
500 m
Term. Year
2 4 3 5 1 6 8 9 10
7
9a. Amazon in January 2000
Amazon was
trading at $84 in
January 2000.
Dot.com retailers for rrst 5 years
Convetional retailers after year 5
Used average
interest coverage
ratio over next 5
years to get BBB
rating.
Pushed debt ratio
to retail industry
average of 15%.
From previous
years
Sales to capital ratio and
expected margin are retail
industry average numbers
All existing options valued
as options, using current
stock price of $84.
!"#$ "& '()*$+ ,-./01 ,-./01 ,-./01 ,-./01 ,-./01 ,-.2-1 ,,./21 ,,.231 ,0./41 ,0.501
!"#$ "& 678$ 4.001 4.001 4.001 4.001 4.001 9.401 9.951 9.391 9.501 9.001
:&$7;<$=> ?"#$ "& @78$ 4.001 4.001 4.001 3.9,1 5.-01 5.091 5.021 2./41 2.441 2.551
!"#$ "& !=A*$=B ,-.421 ,-.421 ,-.421 ,-.4C1 ,-.4,1 ,-.,C1 ,,.3-1 ,,.041 ,0.2/1 /.3,1
!"#"$%" '()*+, -./0//1 -//0//1 2.0//1 ./0//1 3/0//1 4.04/1 4/05/1 -.06/1 -/07/1 60//1
!"#"$%"8 492:3 ; .9.7. ; :9225 ; -5966- ; -:9/.: ; 439764 ; 47924: ; 3394-- ; 3692:7 ; 3:9//6 ;
<="(>+?$@ A>(@?$ B-303.1 B-0671 50-61 20/71 70.51 :0421 :0651 :0741 :0:-1 :0:.1
CDEF B;323 B;:5 ;5/2 ;-9/37 ;-9647 ;494-4 ;49267 ;3946- ;39656 ;39773
CDEFG-B+H B;323 B;:5 ;5/2 ;72- ;-9/.7 ;-9537 ;-92:: ;49--: ;4932/ ;49.45
B !"?$#"8+I"$+ ;6// ;:62 ;-954/ ;-9663 ;-9.53 ;-9677 ;-924- ;-96-: ;-9363 ;:6-
JKJJ B;:3- B;-9/45 B;:7: B;2.7 B;5/7 B;-63 ;-22 ;64. ;-9-25 ;-9277
!"
#$%&#! '
$)*))"
'#%$&+
',%!--
'$++
'$%--$
Aswath Damodaran 7
Terminal year (11)
EBIT (1-t) $1,849
- Reinvestment $ 416
FCFF $1,433
Terminal Value
10
= 1433/(.08-.027) = $27.036
Cost of capital = 11.32% (.983) + 5.16% (.017) = 11.22%
90% advertising
(1.44) + 10% info
svcs (1.05)
Risk Premium
6.15%
Operating assets $9,611
+ Cash 375
+ IPO Proceeds 1000
- Debt 207
Value of equity 10,779
- Options 805
Value in stock 9,974
/ # of shares 574.44
Value/share $17.36
Cost of Debt
(2.7%+5.3%)(1-.40)
= 5.16%
Stable Growth
g = 2.7%; Beta = 1.00;
Cost of capital = 8%
ROC= 12%;
Reinvestment Rate=2.7%/12% = 22.5%
Cost of Equity
11.32%
Weights
E = 98.31% D = 1.69%
Riskfree Rate:
Riskfree rate = 2.7%
+
Beta
1.40
X
On October 5, 2013, Twitter
had not been priced yet, but
the company's most recent
acquisition suggested a
price of about $20/share.
Cost of capital decreases to
8% from years 6-10
D/E=1.71%
Twitter Pre-IPO Valuation: October 5, 2013
Revenue
growth of 55% a
year for 5 years,
tapering down
to 2.7% in year
10
Pre-tax
operating
margin
increases to
25% over the
next 10 years
Sales to
capital ratio of
1.50 for
incremental
sales
Starting numbers
75% from US(5.75%) + 25%
from rest of world (7.23%)
2012 1ralllng 2013
8evenues $316.9 $448.2
CperaLlng lncome -$77.1 -$92.9
Ad[ Cp lnc $4.3
lnvesLed CaplLal $349.1
CperaLlng Margln 0.96
Sales/CaplLal 0.82
! " # $ % & ' ( ) !*
+,-,./,0 &)$1' 2 !4*'&1( 2 !4&&)1! 2 "4%('1! 2 $4*!*1* 2 %4')&1* 2 '4''!1# 2 )4&*&1( 2 !*4('!1! 2 !!4!&$1& 2
56,789:.; <.=>?, "#1# 2 &"1* 2 !#&1# 2 "'#1% 2 %"*1# 2 ()!1% 2 !4#("1" 2 !4)#)1' 2 "4$%&1# 2 "4')!1" 2
56,789:.; <.=>?, 8@9,7 98A,0 "#1# 2 &"1* 2 !#&1# 2 "&%1# 2 #&$1" 2 &!$1" 2 )#'1! 2 !4")#1( 2 !4&!!1$ 2 !4(**1# 2
+,:.-,09?,.9 !&$1# 2 "%$1' 2 #)$1( 2 &!"1* 2 )$(1& 2 !4!)*1' 2 !4#!&1( 2 !4""#1' 2 ($"1( 2 !)%1' 2
BCBB D!$!1*E 2 D!)"1'E 2 D"%(1%E 2 D#$&1&E 2 D%($1$E 2 D%'&1%E 2 D#')1'E 2 '*1* 2 '&(1% 2 !4&*$1& 2
8
1he sources of uncerLalnLy
! Estimation versus Economic uncertainty
! Estimation uncertainty reects the possibility that you could have the wrong
model or estimated inputs incorrectly within this model.
! Economic uncertainty comes the fact that markets and economies can change over
time and that even the best medals will fail to capture these unexpected changes.
! Micro uncertainty versus Macro uncertainty
! Micro uncertainty refers to uncertainty about the potential market for a rms
products, the competition it will face and the quality of its management team.
! Macro uncertainty reects the reality that your rms fortunes can be affected by
changes in the macro economic environment.
! Discrete versus continuous uncertainty
! Discrete risk: Risks that lie dormant for periods but show up at points in time.
(Examples: A drug working its way through the FDA pipeline may fail at some stage
of the approval process or a company in Venezuela may be nationalized)
! Continuous risk: Risks changes in interest rates or economic growth occur
continuously and affect value as they happen.
9
Assessing uncertainty
! 8ank Lhe four rms ln Lerms of uncerLalnLy (leasL Lo mosL) ln your
esumaLe:
" 3M ln 2007
" 1aLa MoLors ln 2010
" Amazon ln 2000
" 1wluer ln 2013
WlLh each company, speclfy Lhe Lype of uncerLalnLy LhaL you face:

!"#$%&' )*+#%+"& ",
)-"&"#.-
/.-," ",
/%-,"
0.*-,121 ",
!"&+&3"3*
3M (2007)
1aLa MoLors (2010)
Amazon (2000)
1wluer (2013)
10
unhealLhy ways of deallng wlLh uncerLalnLy
! Paralysis & Denial: When faced with uncertainty, some of us
get paralyzed. Accompanying the paralysis is the hope that if
you close your eyes to it, the uncertainty will go away
! Mental short cuts (rules of thumb): Behavioral economists
note that investors faced with uncertainty adopt mental short
cuts that have no basis in reality. And here is the clincher.
More intelligent people are more likely to be prone to this.
! Herding: When in doubt, it is safest to go with the crowd..
The herding instinct is deeply engrained and very difcult to
ght.
! Outsourcing: Assuming that there are experts out there who
have the answers does take a weight off your shoulders, even
if those experts have no idea of what they are talking about.
11
1en suggesuons for deallng wlLh uncerLalnLy.
1. Less ls more (Lhe rule on deLall..) (8evenue & margln forecasLs)
2. 8ulld ln lnLernal checks on reasonableness. (relnvesLmenL and 8CC)
3. use Lhe osemng prlnclple (rlsk free raLes & lnauon aL 1aLa MoLors)
4. uraw on economlc rsL prlnclples (1ermlnal value aL all Lhe companles )
3. use Lhe markeL" as a cruLch (equlLy rlsk premlums, counLry rlsk
premlums)
6. use Lhe law of large numbers (8eLa for all companles
7. uon'L leL Lhe dlscounL raLe become Lhe recepLacle for all uncerLalnues.
8. ConfronL uncerLalnLy, lf you can
9. uon'L look for preclslon
10. ?ou can llve wlLh mlsLakes, buL blas wlll klll you.
Aswath Damodaran
11
12
1. Less ls more
12
Principle of parsimony: Estimate
fewer inputs when faced with
uncertainty.
Use auto pilot approaches to
estimate future years
13
A Lougher Lask aL 1wluer
Aswath Damodaran
13
My estimate for 2023: Overall market will be close to
$200 billion and Twitter will about 5.7% ($11.5
billion)
14
2. 8ulld ln lnLernal" checks for
reasonableness.
Aswath Damodaran
14
Check total revenues, relative to the market that it serves
Your market share obviously cannot exceed 100% but there
may be tighter constraints.
Are the margins
and imputed
returns on capital
reasonable in the
outer years?
15
lollow up proposluons on growLh.
! lf you accepL Lhe proposluon LhaL growLh has Lo come from elLher
lncreased emclency (lmprovlng reLurn on caplLal on exlsung asseLs) and
new lnvesLmenLs (relnvesLmenL raLe & reLurn on caplLal):
! Plgh growLh ls easy Lo dellver, hlgh quallLy growLh ls more dlmculL.
! Scallng up ls hard Lo do, l.e., growLh ls more dlmculL Lo susLaln as
companles geL larger.
Aswath Damodaran
15
16
3. use conslsLency LesLs.
! Whlle you can noL grade a valuauon on correcLness" (slnce
dlerenL analysLs can make dlerenL assumpuons abouL
growLh and rlsk), you can grade lL on conslsLency.
! lor a valuauon Lo be conslsLenL, your esumaLes of cash ows
have Lo be conslsLenL wlLh your dlscounL raLe denluon.
! LqulLy versus llrm: lf Lhe cash ows belng dlscounLed are cash ows Lo
equlLy, Lhe approprlaLe dlscounL raLe ls a cosL of equlLy. lf Lhe cash
ows are cash ows Lo Lhe rm, Lhe approprlaLe dlscounL raLe ls Lhe
cosL of caplLal.
! Currency: 1he currency ln whlch Lhe cash ows are esumaLed should
also be Lhe currency ln whlch Lhe dlscounL raLe ls esumaLed.
! nomlnal versus 8eal: lf Lhe cash ows belng dlscounLed are nomlnal
cash ows (l.e., reecL expecLed lnauon), Lhe dlscounL raLe should be
nomlnal
Aswath Damodaran
16
17
1aLa MoLors: ln 8upees and uS dollars
(1.125)*(1.01/1.
04)-1 = .0925
Aswath Damodaran
17
18
4. uraw on economlc rsL prlnclples and
maLhemaucal llmlLs.
! When dolng valuauon, you are free Lo make
assumpuons abouL how your company wlll evolve
over ume ln Lhe markeL LhaL lL operaLes, buL you are
noL free Lo vlolaLe rsL prlnclples ln economlcs and
maLhemaucs.
! uL dlerenLly, Lhere are assumpuons ln valuauon
LhaL are elLher maLhemaucally lmposslble or vlolaLe
rsL laws of economlcs and cannoL be ever [usued.
Aswath Damodaran
18
19
And Lhe excess reLurn" eecL.
Aswath Damodaran
19
!"#$%& ()*+", )#"& -. /#"# .*"*)0 12#3*4 /+56&)
0 $70,409 433,686! $26,390 $23,111
1 $70,409 433,686! $28,263 $24,212
2 $70,409 433,686! $30,393 $23,679
3 $70,409 433,686! $33,394
4 433,686! $37,618
3 433,686! $43,334
$32,148
8lskfree raLe 3.72 3 6.60 2.70
8ClC 6.76 10.39 20 12.00
CosL of caplLal 6.76 10.39 9.61 8.00
20
3. use Lhe markeL as a cruLch. L8 as an
lllusLrauon

Historical
premium
Aswath Damodaran
20
Arithmetic Average Geometric Average
Stocks - T. Bills Stocks - T. Bonds Stocks - T. Bills Stocks - T. Bonds
1928-2012 7.65% 5.88% 5.74% 4.20%
2.20% 2.33%
1962-2012 5.93% 3.91% 4.60% 2.93%
2.38% 2.66%
2002-2012 7.06% 3.08% 5.38% 1.71%
5.82% 8.11%
January 1, 2013
S&P 500 is at 1426.19
Adjusted Dividends & Buybacks
for base year = 69.46
In 2012, the actual cash
returned to stockholders was
72.25. Using the average total
yield for the last decade yields
69.46
Analysts expect earnings to grow 7.67% in 2013, 7.28% in 2014,
scaling down to 1.76% in 2017, resulting in a compounded annual
growth rate of 5.27% over the next 5 years. We will assume that
dividends & buybacks will tgrow 5.27% a year for the next 5 years.
After year 5, we will assume that
earnings on the index will grow at
1.76%, the same rate as the entire
economy (= riskfree rate).
76.97 81.03 85.30 89.80
Expected Return on Stocks (1/1/13) = 7.54%
T.Bond rate on 1/1/13 = 1.76%
Equity Risk Premium = 7.54% - 1.76% = 5.78%
73.12 Data Sources:
Dividends and Buybacks
last year: S&P
Expected growth rate:
S&P, Media reports,
Factset, Thomson-
Reuters
1426.19 =
73.12
(1+r)
+
76.97
(1+r)
2
+
81.03
(1+r)
3
+
85.30
(1+r)
4
+
89.80
(1+r)
5
+
89.80(1.0176)
(r !.0176)(1+r)
5
Country Risk Premiums
July 2013
Black #: Total ERP
Red #: Country risk premium
AVG: GDP weighted average
Angola 3.40 11.13
8enln 8.23 14.00
8oLswana 1.63 7.40
8urklna laso 8.23 14.00
Cameroon 8.23 14.00
Cape verde 6.73 12.30
LgypL 12.00 17.73
Cabon 3.40 11.13
Chana 6.73 12.30
kenya 6.73 12.30
Morocco 4.13 9.88
Mozamblque 6.73 12.30
namlbla 3.38 9.13
nlgerla 3.40 11.13
8wanda 8.23 14.00
Senegal 6.73 12.30
SouLh Afrlca 2.33 8.30
1unlsla 4.73 10.48
Zambla 6.73 12.30
45,.-% 6789: ;;7<6:
Andorra 1.93 7.70
AusLrla 0.00 3.73
8elglum 1.20 6.93
Cyprus 16.30 22.23
uenmark 0.00 3.73
llnland 0.00 3.73
lrance 0.43 6.20
Cermany 0.00 3.73
Creece 10.13 13.88
lceland 3.38 9.13
lreland 4.13 9.88
lsle of Man 0.00 3.73
lLaly 3.00 8.73
LlechLensLeln 0.00 3.73
Luxembourg 0.00 3.73
MalLa 1.93 7.70
neLherlands 0.00 3.73
norway 0.00 3.73
orLugal 3.40 11.13
Spaln 3.38 9.13
Sweden 0.00 3.73
SwlLzerland 0.00 3.73
1urkey 3.38 9.13
uk 0.43 6.20
=7 )3,"$1 ;>7??: <78@:
Argenuna 10.13 13.88
8ellze 14.23 20.00
8ollvla 3.40 11.13
8razll 3.00 8.73
Chlle 1.20 6.93
Colombla 3.38 9.13
CosLa 8lca 3.38 9.13
Lcuador 12.00 17.73
Ll Salvador 3.40 11.13
CuaLemala 4.13 9.88
Ponduras 8.23 14.00
Mexlco 2.33 8.30
nlcaragua 10.13 13.88
anama 3.00 8.73
araguay 3.40 11.13
eru 3.00 8.73
Surlname 3.40 11.13
uruguay 3.38 9.13
venezuela 6.73 12.30
A%+& 4#1,.-% B78C: 87<8:
Canada 0.00 3.73
unlLed SLaLes 0.00 3.73
D",2E 4#1,.-% 9799: 67@6:
Albanla 6.73 12.30
Armenla 4.73 10.48
Azerbal[an 3.38 9.13
8elarus 10.13 13.88
8osnla 10.13 13.88
8ulgarla 3.00 8.73
Croaua 4.13 9.88
Czech 8epubllc 1.43 7.18
LsLonla 1.43 7.18
Ceorgla 3.40 11.13
Pungary 4.13 9.88
kazakhsLan 3.00 8.73
LaLvla 3.00 8.73
LlLhuanla 2.33 8.30
Macedonla 3.40 11.13
Moldova 10.13 13.88
MonLenegro 3.40 11.13
oland 1.63 7.40
8omanla 3.38 9.13
8ussla 2.33 8.30
Serbla 3.40 11.13
Slovakla 1.63 7.40
Slovenla 4.13 9.88
uganda 6.73 12.30
ukralne 10.13 13.88
)7 )3,"$1FG3**.% B7;B: H7HH:
8ahraln 2.33 8.30
lsrael 1.43 7.18
!ordan 6.73 12.30
kuwalL 0.90 6.63
Lebanon 6.73 12.30
Cman 1.43 7.18
CaLar 0.90 6.63
Saudl Arabla 1.20 6.93
uAL 0.90 6.63
/.IIJ1 )%*2 ;7BH: @7;B:
AusLralla 0.00 3.73
Cook lslands 6.73 12.30
new Zealand 0.00 3.73
43*2,%J.% K DL 9799: 67@6:
8angladesh 3.40 11.13
Cambodla 8.23 14.00
Chlna 1.20 6.93
ll[l 6.73 12.30
Pong kong 0.43 6.20
lndla 3.38 9.13
lndonesla 3.38 9.13
!apan 1.20 6.93
korea 1.20 6.93
Macao 1.20 6.93
Malaysla 1.93 7.70
Maurluus 2.33 8.30
Mongolla 6.73 12.30
aklsLan 12.00 17.73
apua nC 6.73 12.30
hlllpplnes 4.13 9.88
Slngapore 0.00 3.73
Srl Lanka 6.73 12.30
1alwan 1.20 6.93
1halland 2.33 8.30
vleLnam 8.23 14.00
4*.% ;7@@: @76?:
6. uraw on Lhe law of large numbers.
! 1o esumaLe Lhe beLa
for 1aLa MoLors
! unlevered beLa for
auLomoblle company =
0.98
! u/L rauo for 1aLa
MoLors = 33.87
! Marglnal Lax raLe ln
lndla = 33.99
! Levered beLa = 0.98 (1+
(1-.3399)(.3387)) = 1.20
22
Aswath Damodaran
23
7. uon'L leL Lhe dlscounL raLe become Lhe
recepLacle for all your uncerLalnLy.
Aswath Damodaran
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24
ConLrasung ways of deallng wlLh survlval rlsk.
! 1he venLure CaplLal approach: ln Lhe venLure caplLal
approach, you hlke Lhe dlscounL raLe" well above whaL
would be approprlaLe for a golng concern and Lhen use Lhls
LargeL" raLe Lo dlscounL your exlL value" (whlch ls
esumaLed uslng a muluple and forward earnlngs).
! value = (lorward Larnlngs ln year n * LxlL muluple)/ (1+ LargeL raLe)
n
! 1he declslon Lree approach:
! value Lhe buslness as a golng concern", wlLh a raLe of reLurn
approprlaLe for a golng concern".
! LsumaLe Lhe probablllLy of survlval (and fallure) and Lhe value of Lhe
buslness ln Lhe evenL of fallure.
! value = Colng concern value (robablllLy of survlval) + Llquldauon
value (robablllLy of fallure)
Aswath Damodaran
24
Aswath Damodaran 25
26
8. ConfronL uncerLalnLy, lf you can.
Aswath Damodaran
26
27
WlLh Lhe consequences for equlLy value.
Aswath Damodaran
27
28
9. uon'L look for preclslon..
! no mauer how careful you are ln gemng your lnpuLs
and how well sLrucLured your model ls, your
esumaLe of value wlll change boLh as new
lnformauon comes ouL abouL Lhe company, Lhe
buslness and Lhe economy.
! As lnformauon comes ouL, you wlll have Lo ad[usL
and adapL your model Lo reecL Lhe lnformauon.
8aLher Lhan be defenslve abouL Lhe resulung
changes ln value, recognlze LhaL Lhls ls Lhe essence
of rlsk.
Aswath Damodaran
28
Forever
Terminal Value= 1064/(.0876-.05)
=$ 28,310
Cost of Equity
13.81%
Cost of Debt
6.5%+3.5%=10.0%
Tax rate = 0% -> 35%
Weights
Debt= 27.3% -> 15%
Value of Op Assets $ 8,789
+ Cash & Non-op $ 1,263
= Value of Firm $10,052
- Value of Debt $ 1,879
= Value of Equity $ 8,173
- Equity Options $ 845
Value per share $ 20.83
Riskfree Rate:
T. Bond rate = 5.1%
+
Beta
2.18-> 1.10
X
Risk Premium
4%
Internet/
Retail
Operating
Leverage
Current
D/E: 37.5%
Base Equity
Premium
Country Risk
Premium
Current
Revenue
$ 2,465
Current
Margin:
-34.60%
Reinvestment:
Cap ex includes acquisitions
Working capital is 3% of revenues
Sales Turnover
Ratio: 3.02
Competitiv
e
Advantages
Revenue
Growth:
25.41%
Expected
Margin:
-> 9.32%
Stable Growth
Stable
Revenue
Growth: 5%
Stable
Operating
Margin:
9.32%
Stable
ROC=16.94%
Reinvest 29.5%
of EBIT(1-t)
EBIT
-853m
NOL:
1,289 m
$24,912
$2,302
$1,509
$ 445
$1,064
Term. Year
2 4 3 1 5 6 8 9 10 7
1 2 3 4 5 6 7 8 9 10
Revenues $4,314 $6,471 $9,059 $11,777 $14,132 $16,534 $18,849 $20,922 $22,596 $23,726
EBIT -$545 -$107 $347 $774 $1,123 $1,428 $1,692 $1,914 $2,087 $2,201
EBIT(1-t) -$545 -$107 $347 $774 $1,017 $928 $1,100 $1,244 $1,356 $1,431
- Reinvestment $612 $714 $857 $900 $780 $796 $766 $687 $554 $374
FCFF -$1,157 -$822 -$510 -$126 $237 $132 $333 $558 $802 $1,057
Debt Ratio 27.27% 27.27% 27.27% 27.27% 27.27% 24.81% 24.20% 23.18% 21.13% 15.00%
Beta 2.18 2.18 2.18 2.18 2.18 1.96 1.75 1.53 1.32 1.10
Cost of Equity 13.81% 13.81% 13.81% 13.81% 13.81% 12.95% 12.09% 11.22% 10.36% 9.50%
AT cost of debt 10.00% 10.00% 10.00% 10.00% 9.06% 6.11% 6.01% 5.85% 5.53% 4.55%
Cost of Capital 12.77% 12.77% 12.77% 12.77% 12.52% 11.25% 10.62% 9.98% 9.34% 8.76%
Amazon.com
January 2001
Stock price = $14
9b. Amazon in January 2001
Aswath Damodaran 29
30
1o lllusLraLe: ?our mlsLakes versus markeL
mlsLakes..
$0.00
$10.00
$20.00
$30.00
$40.00
$50.00
$60.00
$70.00
$80.00
$90.00
2000 2001 2002 2003
Time of analysis
Amazon: Value and Price
Value per share
Price per share
Aswath Damodaran
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31
10. ?ou can make mlsLakes, buL Lry Lo keep blas
ouL..
! When you are wrong on lndlvldual company valuauons, as
you lnevlLably wlll be, recognlze LhaL whlle Lhose mlsLakes
may cause Lhe value Lo be very dlerenL from Lhe prlce for an
lndlvldual company, Lhe mlsLakes should average ouL across
companles.
! uL dlerenLly, lf you are an lnvesLor, you have can make Lhe law of
large numbers" work for you by dlverslfylng across companles, wlLh
Lhe degree of dlverslcauon lncreaslng as uncerLalnLy lncreases.
! lf you are blased" on lndlvldual company valuauons, your
mlsLakes wlll noL average ouL, no mauer how dlversled you
geL.
! 8ouom llne: ?ou are beuer o maklng large mlsLakes and
belng unblased Lhan maklng smaller mlsLakes, wlLh blas.
Aswath Damodaran
31
32
And don'L forgeL: lL ls noL [usL Lhe value LhaL you
are uncerLaln abouL.
INTRINSIC
VALUE
PRICE
Value
Price
THE GAP
Is there one?
Will it close?
Drivers of intrinsic value
- Cashows from existing assets
- Growth in cash ows
- Quality of Growth
Drivers of price
- Market moods & momentum
- Surface stories about fundamentals
Tools for pricing
- Multiples and comparables
- Charting and technical indicators
- Pseudo DCF
Tools for intrinsic analysis
- Discounted Cashow Valuation (DCF)
- Intrinsic multiples
- Book value based approaches
- Excess Return Models
Tools for "the gap"
- Behavioral nance
- Price catalysts
Drivers of "the gap"
- Information
- Liquidity
- Corporate governance
Value of cashows,
adjusted for time
and risk
Aswath Damodaran
32
And here ls how lL plays ouL.
33
Aswath Damodaran
My valuation of Apple with revenue growth of 6%
(Normal, !=3%), target pre-tax margin of 30%
(Uniform,25%-35%) and cost of capital of 12.5%
(Triangle, 11-14%). There is a 90% chance that
Apple is undervalued at $440/share.
The value process
My valuation of Apple in January 2013
0.0
10.0
20.0
30.0
40.0
30.0
60.0
70.0
80.0
90.0
1 monLh 6 monLhs 1 year 3 years 10 years
ME1 N,.-.&O N,"-1**P 4$$J1
Cap wldens Cap sLays same Cap narrows
34
SLraLegles for managlng Lhe rlsk ln Lhe closlng"
of Lhe gap
! 1he karmlc" approach: ln Lhls one, you buy (sell shorL) under
(over) valued companles and slL back and walL for Lhe gap Lo
close. ?ou are lmpllclLly assumlng LhaL glven ume, Lhe markeL
wlll see Lhe error of lLs ways and x LhaL error.
! 1he caLalysL approach: lor Lhe gap Lo close, Lhe prlce has Lo
converge on value. lor LhaL convergence Lo occur, Lhere
usually has Lo be a caLalysL.
! lf you are an acuvlsL lnvesLor, you may be Lhe caLalysL yourself. ln facL,
your acL of buylng Lhe sLock may be a sumclenL slgnal for Lhe markeL
Lo reassess Lhe prlce.
! lf you are noL, you have Lo look for oLher caLalysLs. Pere are some Lo
waLch for: a new CLC or managemenL Leam, a blockbusLer" new
producL or an acqulsluon bld where Lhe rm ls LargeLed.
Aswath Damodaran
34