modelsmorefeasible,thereismuchto besaid infavor of
simpler models that require fewer inputs.
3.Respectthebasiclawsofeconomics.Themostegregious
mistakes in valuationarise when analystsignorethe basic
lawsofeconomics.Forinstance,whilethereisabsolutelyno
waytojustifytheassumptionthatthefirmcangrowatarate
higherthantheeconomyforever,manyanalystscontinueto
make that assumption.
- Match cash flows to discount rates. The key to good
valuationsisto ensurethatyoudon’t mismatchcash flows
anddiscountrates.Usingthecostofequitytodiscountcash
flowstothefirm,anominalratetodiscountrealcashflows,
oradollardiscountrateonpesocashflowswillalwaysyield
incorrect estimates of value. - Preserve internalconsistency. Whenvaluing companies,
wemakeassumptionsaboutgrowth,risk,andcashflows,and
itisimperative thatwepreserveinternalconsistency when
making these assumptions. Assuming that a company will
growinthelongtermwithnoreinvestmentandlowriskmay
yield a high value, but is it feasible? High growth rates
generallyrequiresubstantialreinvestmentanda willingness
to be exposed to risk, and makingthese assumptions may
yield a lower but a more defensible estimate of value.
6.Keepmacroeconomicviewsoutofvaluations.Whileallof
ushaveviewsontheeconomy,interestrates,andexchange
ratesthatweareeagertosharewiththerestoftheworld,the
valuationofafirmisnottherightforumforexpressingthese
views.Buildingintoavaluationthebeliefthatinterestrates
willriseoverthenext 10 yearswillgeneratealowervaluefor