words,theassumptionthatpretaxoperatingmargins
willstayat 20 percent(abigassumptionthatdoubles
thevalueofthecompany)hastocompetewiththe
assumptionthataccountsreceivablewilldeclinefrom
5 percentofrevenuesto 4 percentofrevenuesover
thenext 10 years(asmallassumptionthathasalmost
no impact on value).The Principle of Parsimony
Inthephysicalsciences,theprincipleofparsimonydictates
that we try the simplest possible explanation for a
phenomenonbeforewemoveontomorecomplicatedones.
We would be well served adopting a similar principle in
valuation.Whenvaluinganasset,wewanttousethesimplest
modelwecangetawaywith.Inotherwords,ifwecanvalue
anassetwiththreeinputs,weshouldnotbeusingfive.Ifwe
canvalueacompanywiththreeyearsofcashflowforecasts,
forecasting 10 years of cash flows is asking for trouble.
Theproblemwithall-in-onemodelsthataredesignedtovalue
allcompaniesisthattheyhavetobesetuptovaluethemost
complicatedcompanies thatwe willface and notthe least
complicated.Thus,weareforcedtoenterinputsandforecast
valuesforsimplercompanies thatwereally donot needto
estimate.Intheprocess,wecanmanglethevaluesofassets
thatshouldbeeasytovalue.Consider,forinstance,thecash
andmarketablesecuritiesheldbyfirmsaspartoftheirassets.
Thesimplestwaytovaluethiscashistotakeitatfacevalue.
Analystswhotry to builddiscountedcash flowor relative
valuationmodelstovaluecash oftenmisvalueit,either by
usingthewrongdiscountrateforthecashincomeorbyusing
the wrong multiple for cash earnings.