Damodaran on Valuation

Aswath Damodaran

2 ideas

1. Match cash flows to discount rates

   Cash flows to equity (after interest and debt payments) must be discounted at the cost of equity, while cash flows to the firm (before debt payments) must be discounted at the weighted average cost of capital. Mixing them, such as discounting equity cash flows at the WACC, systematically overstates or understates value. The discount rate must also match the currency and inflation basis of the cash flows, nominal with nominal and real with real.

2. Relative valuation measures price, not value

   Valuing a firm with multiples such as P/E or EV/EBITDA against comparable firms tells you whether it is cheap or expensive relative to the group, not whether it is correctly valued in absolute terms. If the whole sector is overpriced, a stock that looks cheap on multiples can still be overvalued. Each multiple implicitly assumes the firm and its comparables have similar growth, risk, and cash flow potential, so those fundamentals must be controlled for explicitly.

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