Valuationmodelshavebecomemoreandmorecomplexover
thepasttwodecadesasaconsequenceoftwodevelopments.
Ontheoneside,computersandcalculatorshavebecomefar
morepowerful andaccessible.Withtechnologyasourally,
tasksthatwouldhavetakenusdaysintheprecomputerera
can be accomplished in minutes. On the other side,
informationisbothmoreplentifulandeasiertoaccessand
use.Wecandownloaddetailedhistoricaldataonthousandsof
companiesand usethedataaswesee fit.Thecomplexity,
though,hascomeatacost.Inthissection,weconsiderthe
trade-off on complexityand how analystscan decide how
much to build into models.
More Detail or Less Detail
A fundamental question that we all face when doing
valuationsishowmuchdetailweshouldbreaka valuation
downinto.Therearesome whobelievethatmoredetailis
alwaysbetterthanlessdetailandthattheresultingvaluations
aremoreprecise.Wedisagree.Thetrade-offonaddingdetail
isasimpleone.Ontheonehand,moredetailgivesanalystsa
chancetousespecificinformationtomakebetterforecastson
eachindividualitem.Ontheotherhand,moredetailcreates
theneedformoreinputs,withthepotentialforerrorineach
one,andgeneratesmorecomplicatedmodels.Thus,breaking
working capital down into its individual
components—accounts receivable, inventory, accounts
payable, suppliercredit,and thelike—gives an analystthe
discretiontomakedifferentassumptionsabouteachitem,but
thisdiscretionhasvalueonlyiftheanalysthasthecapacityto
differentiate between the items.
Cost of Complexity