The Little Book of Valuation
Summary
Damodaran, who teaches valuation at NYU Stern, compresses his textbook material into a short book for general readers. It covers the two approaches, intrinsic valuation through discounted cash flow and relative valuation through multiples, and then applies both to companies at different stages of their life cycle.
The technical content covers the components: estimating cash flows, the difference between accounting earnings and cash flow, the treatment of research and development and other capitalised expenses, estimating growth from reinvestment rate and return on capital rather than from historical growth rates, estimating discount rates including cost of equity and cost of capital, and the terminal value, which he notes is usually the majority of the value and receives the least attention.
The life cycle framing is the organising device. Young growth companies require different treatment because they have no history and negative earnings, so valuation must be built from the market size and expected margin. Mature companies can be valued from current operations. Declining companies require attention to the value of assets in liquidation. Financial firms require a different approach because debt is raw material rather than capital. Cyclical and commodity firms must be valued on normalised earnings across the cycle rather than on current results.
Damodaran's core position is that valuation is a discipline for making assumptions explicit rather than a method for producing a correct number, and that the value of the exercise is in identifying which assumption the price depends on. The book is compressed and readers wanting the full treatment should use his textbook or his freely published data and spreadsheets.
Key takeaways 7
- Valuation makes assumptions explicit rather than producing a correct number, and its value is in identifying which assumption the answer depends on.
- Growth should be estimated from the reinvestment rate multiplied by the return on capital, not extrapolated from historical growth rates.
- Terminal value usually accounts for the majority of a discounted cash flow valuation and receives the least analytical attention.
- Companies at different life cycle stages require different valuation approaches, and applying a mature-company method to a young growth company produces nonsense.
- Financial firms cannot be valued with standard enterprise methods because debt is their raw material rather than a financing choice.
- Cyclical and commodity companies must be valued on normalised earnings across a full cycle, since current earnings reflect where in the cycle the company sits.
- Relative valuation through multiples embeds the same assumptions as a discounted cash flow model while concealing them, which makes it easier and less honest.
Who should read it
Investors who want a compressed working introduction to valuation methods matched to company life cycle stage.
About Aswath Damodaran
Kerschner Family Chair Professor of Finance, NYU Stern School of Business
His valuation textbooks and freely published datasets are the default reference used across academia, banking and investing.
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