firm in question—this can come from legal
restrictions on competition or a significant
competitive edge.- Donotdoublecountoptions.Alltoooften,analysts
incorporatetheeffectofoptionsonfundamentalsin
the company value and then proceed to add on
premiumstoreflectthesameoptions.Consider, for
instance,theundevelopedoilreserves ownedbyan
oil company. While it is legitimate to value these
reservesasoptions,weshouldnotaddthisvaluetoa
discounted cash flow valuation of the company if
yourexpectedgrowthrateintheDCFvaluationisset
higher because of the firm’s undeveloped reserves.
TEN STEPS TO BETTER VALUATIONS
Attheriskofrepeatingmuchofwhatwehavealreadysaidin
earlier chapters, we can now summarize some general
propositions about how we can improve the quality of
valuations.
1.Minimizebiasinthevaluationprocess.InChapter1,we
arguedthattheproblemwithmostvaluationsisthebiasthat
permeatestheprocess.Analystswhobringstrongpriorviews
aboutacompany’sstandingasunder-orovervaluedorhave
theircompensationtiedtothevaluationresultsarelikelyto
generate valuations reflecting their biases. Improving
valuationmodelswilldolittletoimprovetheprocessunder
these circumstances.
- Use parsimonious models. While technology and the
availability of data have made more complex valuation