As a fan of Aswath Damodaran, the NYU valuations professor, I picked up The Little Book of Valuation to review whether it’s worth having on your bookshelf.
My concluding review is that like the title of the book, it’s a “little book” that has a good summary of valuation concepts and is worth referencing when you need a reminder of certain topics or formulas.
One small problem I had with it was that it ranged wide in the level of explanation – from really beginner concepts to some deep concepts that you don’t necessarily need to know. So, a true beginner might find 70% of the material helpful while an avid valuation expert might only find 10% helpful.
No matter, this book is by far one of the most useful valuation books out there.
What makes it superior to other valuation books is that Professor Damodaran provides all the excel tools that go along with the book on his webpage right here.
It’s kind of like getting a CD-rom included in your textbook back in the day.
Let me get into a little more detail for you and tell you who I think the book is geared towards, what I liked/disliked about the book, and some highlights from the book.
Who Is The Book For?
Because the book introduces concepts at a fairly introductory level (before it goes pretty quickly into the deep end), I think the book is good for beginners but only if they’ve had a little bit of exposure to Finance (like half a semester of Finance 101 class).
If you’ve never done any valuation before and also have never been exposed to any Finance concepts, the book will be a lot more useful if you read it in conjunction with watching some introductory Finance videos that are out there.
The book also acts as a good reminder of concepts for someone who has done valuation but doesn’t do it everyday and needs a refresher.
So, the prime target audience I would say is someone who is at novice to amateur level in valuing companies.
They will especially find this book really helpful to keep on their bookshelf and reference when they’re infrequently doing valuation, because the concepts in the book are simplified and very organized. For example, the book lists 4 components of DCF valuation (or intrinsic valuation) or for relative valuation, the book lists 4 keys to remember when using multiples.
What I Liked / Disliked
- I love lists. So, I really like how the book organizes concepts in each topic into lists. For example, when valuing companies, look for 3 key value drivers. Or, remember these 4 keys when valuing companies using multiples.
- I really like that there is a chapter for valuing companies in different maturity stages of the lifecycle – from early stage to declining companies. This helps you become a more seasoned valuator by remembering the different value drivers to look for depending on how mature the company is.
- One thing I really like that the book teaches is how each company has different value drivers that drive the business. This is an obvious concept, but through many company examples described in the book, it gets your mind to think in terms of looking for what those key value drivers are for each company in order to craft a narrative for that specific company as opposed to just going through the motions of technically doing the valuation.
- Like many valuation books out there, The Little Book of Valuation also shows the formulas and tables to reference when coming up with input assumptions, but it’s hard to follow without an active voiceover and a dynamic spreadsheet showing the underlying calculations. This perhaps isn’t the fault of the book but a flaw in trying to understand how to value companies from a static book.
- Similar to the previous point, anyone can go through the motions of valuing a company, but in order to get to a point where you’re confident with the valuation number, I firmly believe that you really need to see examples of a company valuation being done over and over again. Again, this is what’s always lacking from static books, so I can’t fault this book specifically about it.
Highlights From The Book
Essentially every company valuation book starts with going over the ways to value a company; i.e. cash flow valuation, relative valuation (using comparable multiples), calculating the net book value or net asset value. And this book is no different.
But again, the highlight for me is how every concept is organized into lists. Here are some highlighted lists from the book that make this book stand out.
- 4 components of the intrinsic value calculation are:
- Cash flows from existing assets
- Expected growth in these cash flows during an expected period of time
- The cost of financing the asset
- Estimate of what the firm will be worth at the end of the forecast period
- 3 steps to relative valuation are:
- Find comparable assets
- Scale the market prices to a common variable to generate standardized prices that are comparable across assets
- Adjust for differences
- 4 keys to using multiples correctly
- Make sure numerator and denominator are consistent (e.g. forward, current, Trailing)
- Because of outliers, using an average leads to statistics that are way off. Many services leave out the outliers and also not meaningful multiples like negative earnings. Be skeptical of multiples where they leave out a lot from the original sample b/c the statistics might be skewed
- Every multiple is a function of 3 variables (see next point)
- Compare the multiple values with similar profiles (e.g. same industry)
- Every multiple is a function of 3 variables.
- Cash flow generating potential
- Every multiple has a companion variable where if you look at the 2 together and there’s a mismatch in direction, then it reveals if the company is undervalued. A couple examples from the table listed in the book are:
- For a PE ratio, the companion variable is expected growth. If there’s a mismatch in that the PE ratio is low but the expected growth rate for earnings is high, then the company is undervalued
- For a Price to Sales ratio, the companion variable is net margin. If there’s a mismatch in that the P/S ratio is low but the net profit margin is high, then it’s an indication that the company is undervalued
- The book lists 3 typical value drivers to look for when valuing companies of different maturity. One example value driver from the book for the varying stages of the company is:
- Early stage company: an example value driver is survival skills; i.e. what’s the likelihood of this young company surviving? Attributes that will help answer this question include:
- Big market potential
- Disciplined spending (and monitoring)
- Access to capital
- Not dependent on just a few key people but a solid team and backup
- Growth company: an example value driver is if the company is generating excess returns that are significantly higher than its cost of funding. So, cost of equity and cost of debt should decline as revenue growth becomes more stable and margins become higher – this affects the risk rate assumption
- Mature company: an example value driver is looking at whether the performance indicators are lower compared to its peers. For example, if the operating margins are low relative to the sector or the company has low returns on capital relative to cost of capital and very low debt ratios, they can indicate that the company is not being managed optimally and there’s room for growth
- Declining company: an example value driver is looking at the consequences of distress – will the assets of the firm be sold and the distress proceeds used to pay down debt?
This is a very handy little valuation book especially for beginners and for people who know how to value a company but need a refresher from time to time.
The book covers the standard various ways to value a company, including discounted cash flow and relative valuation. And what’s more, it doesn’t just tell you how to do something but also why and what to look for in the data.
Perhaps the most useful part about The Little Book of Valuation is that there is an accompanying webpage that provides all the tools to download for free so you can practice for yourself.
I highly recommend this book, especially to have as a physical copy, so you can reference how to find a particular component of valuation or which value drivers to focus on for a company in a particular lifecycle stage.
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