Damodaran on Valuation: Security Analysis for Investment and Corporate Finance
Summary
Damodaran wrote this as the more advanced companion to his Investment Valuation, concentrating on the cases where standard methods break down.
The foundation covers the three approaches: discounted cash flow, relative valuation using multiples, and contingent claim valuation using option pricing. His recurring argument is that all valuation contains bias, that the number of assumptions determines how much uncertainty the answer carries, and that a valuation should be judged by whether its assumptions are internally consistent rather than by whether it produces a precise figure.
The difficult cases are the substance. He covers firms with negative earnings, where multiples cannot be applied and cash flows must be normalised or projected from revenue; young companies with no history, where the estimation must start from the market rather than from the firm; firms in financial distress, where the probability of failure must be modelled explicitly rather than embedded in a discount rate; private companies, where beta cannot be estimated from market prices and where illiquidity must be discounted; cyclical and commodity companies, where the point in the cycle determines everything; and firms with intangible assets whose accounting treatment as expenses rather than investment distorts every reported measure.
The contingent claim material treats equity in a highly leveraged firm as a call option on the assets, natural resource reserves as options on the commodity, and patents as options on development, and shows when option valuation gives a materially different answer from discounted cash flow.
The relative valuation sections examine multiples systematically, deriving what each implies about growth, risk and payout, and showing how to control for the differences that make comparable companies not comparable.
The book requires financial background. Damodaran publishes his datasets, spreadsheets and updated material publicly, which readers should use alongside any edition.
Key takeaways 7
- Every valuation contains bias, and the honest response is to state the assumptions rather than to claim precision.
- The number of assumptions in a valuation determines how much uncertainty the answer carries, regardless of how precise it looks.
- Firms with negative earnings require normalising or projecting from revenue, because multiples cannot be applied to a negative number.
- Distressed firms require the probability of failure to be modelled explicitly rather than buried in a higher discount rate.
- Equity in a highly leveraged firm is a call option on the assets, which is why it retains value when the firm is technically insolvent.
- Accounting that expenses research and brand building understates both assets and earnings, which distorts every derived measure.
- Every multiple implies specific assumptions about growth, risk and payout, and using one without deriving those assumptions is guesswork.
Who should read it
Analysts and investors who need valuation methods for the cases where standard approaches fail, including distressed, young, cyclical and private companies.
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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