• Thursday, March 28, 2024
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Aswath Damodaran: Valuations: Key lessons to take away

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The Second edition of the Coronation Capital Masterclass which discussed “Corporate Finance and Business Valuation” with Professor Aswath Damodaran of the New York University Sterns Business School, came to end yesterday.

In the four-day valuation master class held on July 20 – 21 and 27 – 28, sponsored by Coronation Capital, the astute professor taught participants the importance of consistency and the 3p valuation approach in arriving at the value of a firm. He also explained the impact of macroeconomic conditions on Business valuation.

Damodaran has published several books and articles on equity valuation and corporate finance and has been featured in the Journal of Finance, the Journal of Financial Economics, and the Review of Financial Studies. Professor Damodaran has been voted ‘Professor of the Year’ by Stern’s graduating MBA class five times and has been awarded NYU’s Excellence in Teaching and Distinguished Teaching award; Coronation is delighted to bring him to Nigeria for a second time.

During the zoom lecture, professor Damodaran opined that valuation is not a science but an act and that valuing and that asset is not the same as pricing an asset.

To him a good valuation comes with a story and numbers, and that you could be wrong if you put all the right input into valuation.

The cost of capital is the weighted average cost of capital (WACC) used to discount cash flow to the present value. Many business use the combination of debt and equity to finance their business, hence, WACC is the cost of various sources of finance in the capital structure of a firm.

The cost of equity is driven by the marginal investors of the company, those who own a lot of stocks such as mutual funds and pension funds. These investors can diversify their risks.

Beta is a measure of the volatility—or systematic risk—of a security or portfolio compared to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which describes the relationship between systematic risk and expected return, for assets (usually stocks).

A Beta greater than 1 the security price tends to be more than the market; and the higher the beta the higher the cost of equity.

A key takeaway from the lecture is that in valuing firms a valuator needs to make his choice early and be consistent from the outset so as to avoid mistakes. What this means is that he should stick to one currency while carrying out the assignment.

The best way to value a bank is to use the marketable securities and use the pricing of those discount factors instead of deploying the discounted cash flow model.

Many equity research analysts across the globe use the dividend valuation model which discounts the expected future dividend stream to arrive at the intrinsic value of a stock.

Damodaran believes synergies can increase and decrease growth in mergers and acquisitions, and that he tries to look at the track record of the company.

“Most of the time synergies do not just show up, you work for it and most companies do not do it,” said the professor.

Another takeaway from the lecture is that we can use government bonds as our risk free rate of returns. It is risk free because unlike companies government cannot go bankrupt, instead, it can raise taxes or sell assets.

However, the government can default on debt as Argentina has done so severally over the past 25 years. Also, government often choose not to print money to pay off their debt because it is better to default than to debase their currencies.

Of course, risk free rate differs from one country to another; it is high in Zambia’s Kwacha, the Nigerian Naira and Turkish Lira; but low in Japanese yen and the United States dollars. In some currencies the risk free rate is negative.

Inflation is paramount to nominal risk free rate because a country beleaguered by inflationary pressure will have a high rate.

Domodaran believes in the absence of government bond rates, the inflation rate can be used as the risk free rate because it avoids ambiguity. “If you make a mistake in your inflation then it will show in your both cash flow and discount rate,”

The New York University professor said he does not trust the government bond rate for many countries because they can default and that with inflation rate approach you will always get it right.

Globalization is paramount to valuation as the world is evolving. For instance, if you are valuing Coca Cola, you are not valuing an American company because it generates 60 percent of its revenue outside the United States.

“When l want to value a company I need the risk premium not just of the country the company is incorporated but of the rest of the world,” said Damodaran.

Damodaran have warned global investors to avoid Nigerian stocks like plague because of the macroeconomic uncertainties.

Trust factor matters in valuation and managing cash as investors discount a stock whose companies have a bad history, and relying on the judgement of such executives could lead to loss of significant investment.

A rational investor will not put his money in Hewlett-Packard Company or HP, as the American multinational information technology company has ran 10 failed acquisitions in the last 10 years.

However, Apple Inc, one of the most valuable companies in the world, has been run with discipline. It has a cash balance of $250 billion, vey close to Nigeria’s GDP of $395 billion.