There are many areas in valuation where remains the scope for disagreement, including how to estimate the true value and how long it will take prices to adjust to the true value. But asset prices cannot be justified merely by using the argument that other investors are willing to pay a higher price in the future. Like all analytical disciplines, valuation has developed its own Myths.
1: A valuation is an objective search for significant value. All valuations are biased. However, the questions are how much and in which direction. The direction in the magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid.
2: Since valuation models are quantitative, valuation is better. However, one’s understanding of a valuation model is inversely proportional to the number of inputs required for the model. Moreover, the simpler valuation model do much better than complex ones. It looks obvious that creating a model additional complete and sophisticated ought to yield higher valuation. But it is not necessarily so. As models become more complex the number of inputs needed to value a firm tends to increase. Problems are combined once models become too complicated to become “black boxes.” once a valuation fails the blame gets connected to the model instead of the analyst. Valuer often complains “It was not my fault. The model did it.” Three points are common and important in all valuation works. The first one is the principle of parsimony, which essentially states that you do not use more inputs than what is actually needed. The second one is, there should be a trade-off between additional benefit arising from more inputs and cost arising from input errors and using more number of inputs. The third one is models do not value companies but valuer does. This is a time of excessive information. Identifying the minimum relevant information is almost as important as the valuation models and techniques that a valuer uses to value a firm.
3: A well researched and well-done valuation is timeless. The value obtained in any valuation model is affected by firm-specific as well as market information. As a consequence, the worth can amendment as new info is unconcealed. Given the constant flow of information into financial markets, valuation is done on a firm age quickly and has to be updated to reflect the correct information. However, information about the state of the economy and the level of interest affects all valuation in an economy. When analysts amendment their valuation, they’re going to doubtless be asked to justify them and in some cases the actual fact that valuation amendment over time is viewed as a tangle. The best response may be the one that when one was criticized for changing his position on a major economic issue: “When the facts change I change my mind and what do you do, sir?
4: an honest valuation provides an explicit estimate valuable. However, the reality remains that there’s no conception of precise valuation. The payoff to valuation is greatest once the valuation is least precise.
5: to create cash on valuation, you’ve got to assume that markets are inefficient. If a market is efficient than market price is the best estimate of value. However, it’s been by trial and error tested that no single market is economical within the sturdy from sense. It is recognized that the market makes mistakes but finding those mistakes requires a combination of skill and luck. This view of markets leads to the following conclusions: First if something looks good to be true, a stock looks obviously undervalued or overvalued is properly not true. Second, when the value from an analysis is significantly different from the market price, start off with the presumption that the market is correct; then you have to convince yourself that this is not the case before you to conclude that something is over or undervalued. The higher standard may lead you to be more cautious in following through on valuation but given the difficulty of beating the market this is not an undesirable outcome
6: The product of valuation (i.e., value) matters and not the valuation. Valuation models focus exclusively on the outcome. That is the value of the company and whether it is over or undervalued. In most of the cases valuable points inside are missed out that can be obtained from the process of valuation and can answer some of the most fundamental questions, e.g., • What is the appropriate price to pay for high growth? • What is a brand name worth? • How important is to return and project? • What is the effect of the profit margin on value?
7: what proportion a business is value depends on what the valuation is employed for. The value of a business is its fair market value, that is what a willing buyer will pay a willing seller when each is fully informed and under no pressure to transact.
