Damodaran on Valuation_ Security Analysis for Investment and Corporate Finance ( PDFDrive )

(Hop HipldF0AV) #1

A parallel and related question to how much detail there
should be in a valuation is the one of how complex a
valuationmodelshouldbe.Thereareclearcoststhatwepay
as models become more complex and require more
information.



  • Information overload. More information does not
    alwaysleadtobettervaluations.Infact,analystscan
    becomeoverwhelmedwhenfacedwithvastamounts
    ofconflictinginformation,andthiscanleadtopoor
    inputchoices.Theproblemisexacerbatedbythefact
    thatanalystsoftenoperateundertimepressurewhen
    valuing companies. Models that require dozens of
    inputstovalueasinglecompanyoftengetshortshrift
    fromusers.Amodel’soutputisonlyasgoodasthe
    inputs that go into it; it is garbage in, garbage out.

  • Black box syndrome. The models become so
    complicatedthattheanalystsusingthem nolonger
    understand their inner workings. They feed inputs
    intothemodel’sblackboxand theboxspitsouta
    value. Ineffect, the refrainfrom analysts becomes
    “The model valued the company at $30 a share”
    ratherthan“Wevaluedthecompanyat$30ashare.”
    Of particular concern should be models where
    portionsofthemodelsareproprietaryandcannotbe
    accessed(ormodified)byanalysts.Thisisoftenthe
    case with commercial valuation models, where
    vendors have to keep a part of the model out of
    bounds to make their services indispensable.

  • Bigversussmallassumptions.Complexmodelsoften
    generate voluminous and detailed output and it
    becomes very difficult to separate the big
    assumptions from the small assumptions. In other

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