Due Diligence

Valuation is the systematic process of estimating the worth of a business, investment, or asset, typically with the objective of informing decisions such as investment, merger and acquisition, financial reporting, or dispute resolution. In essence, it translates financial performance and market expectations into a well-founded assessment of value.

Bases and Contributors to Value

A comprehensive valuation integrates multiple perspectives and contributors, notably:

• Intrinsic Value: The present value of future expected cash flows, discounted at an appropriate rate, often using models such as discounted cash flow (DCF). This approach isolates company fundamentals.

• Relative Value: Benchmarks the asset or business against comparable peer group entities using market multiples (such as Price/Earnings, EV/EBITDA, Price/Book). This captures market sentiment and comparable performance.

• Synergy Value: Arises primarily during mergers and acquisitions, capturing the incremental value generated when two entities combine, often through cost savings, enhanced growth prospects, or improved market power.

• Return on Equity (ROE) and Growth: ROE serves as a proxy for profitability relative to shareholders’ capital, and, coupled with growth projections, materially influences equity valuation via frameworks such as the Gordon Growth Model or residual income models. Sustained high ROE and growth enhance intrinsic value.

• Asset-Based Value: Focuses on the net market value of tangible and intangible assets less liabilities — frequently used where earnings are volatile or asset composition dominates (e.g., real estate, liquidation).

• Market Value: Reflects real transaction prices in public or private markets, which may diverge from fundamentally assessed value due to liquidity, sentiment, or market imperfections.

Contributors to value thus include both quantitative measures (free cash flow, earnings growth, capital structure) and qualitative factors (management effectiveness, competitive position, macroeconomic trends).

Principal Theorist: Aswath Damodaran

The most influential contemporary theorist on valuation is Professor Aswath Damodaran. Damodaran, often termed the “Dean of Valuation,” is Professor of Finance at the Stern School of Business, New York University.

Backstory and Relationship with Valuation:

• Damodaran has devoted much of his academic and practical career to the development, refinement, and dissemination of valuation methodologies.
• His work integrates DCF analysis, relative valuation, and real option methodologies, consistently emphasising the importance of underlying assumptions and the dangers of mechanical application.
• He is renowned for demystifying the valuation process through accessible writings, open lectures, and robust empirical evidence, making advanced valuation concepts practical both for students and practitioners.

Biography:

• Education: Professor Damodaran earned his MBA and PhD from the University of California, Los Angeles (UCLA).
• Academic Contributions: Having started teaching at NYU in 1986, he has published seminal texts including “Damodaran on Valuation,” “Investment Valuation,” and “The Little Book of Valuation.”
• Influence: Beyond academia, he is respected globally by investment professionals, policymakers, and corporate decision-makers for his analytical rigour and unbiased approach.
• Philosophy: Damodaran is an advocate of transparency, rigorous challenge of assumptions, and adapting valuation techniques to the specific context—highlighting that valuation is as much an art as a science.

Key Principles

Good valuation practice, as highlighted by leading institutions, insists on:

• Specificity to Time and Context: Valuations reflect conditions, company performance, and market factors at a specific date and should be regularly updated.
• Objective and Transparent Methodology: A clearly articulated process enhances credibility and utility.
• Market Dynamics: Factors such as liquidity and buyer competition can result in market values that deviate from fundamental values.

Limitations

Valuation is inherently subjective — different inputs, models, or market perspectives can yield a range of plausible values (sometimes widely divergent). Accordingly, expertise and judgement remain crucial, and transparency about assumptions and methods is essential.