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The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies 1st Edition
There is a newer edition of this item:
- ISBN-109780130406521
- ISBN-13978-0130406521
- Edition1st
- PublisherFt Pr
- Publication dateJanuary 1, 2001
- LanguageEnglish
- Dimensions6.25 x 1.25 x 9 inches
- Print length479 pages
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From the Inside Flap
Do the old rules still apply? Do we need new valuation metrics, or are the old metrics flexible enough to deal with the companies that constitute the new economy? Can you value a company that has no earnings, no history, and no comparable firms? These are the questions that I have heard repeatedly over the last few years. I have always believed the fundamentals that determine value are the same, no matter what company you value and what market it is in. Increasingly, though, I have faced skeptical audiences who are unwilling to take this belief at face value and have demanded proof that America Online, Amazon, or Priceline can be valued with traditional models.
The genesis for this book was a paper I did on valuing Amazon in March 2000, where a discounted cash flow model yielded a value of $34 per share. Since the stock was trading at $80 at that time, there were many who viewed the valuation as either excessively pessimistic or as missing something. The interest in the paper led me to think about writing a book, but I expanded it to cover both new technology and old technology firms. While there are differences in estimation that arise across these firms, I believe that they have far more in common. Why technology firms? I believe that traditional valuation books and models (and I count my book on investment valuation among the culprits) have tended to concentrate on valuing manufacturing or traditional service firms. Technology firms are different. They expand by investing in research and through acquisitions and not by building plant and equipment. Many of them have astronomical growth rates in revenues and often, very little in current earnings. Their assets are often patents, technology, and skilled employees. I look at how the notions of capital expenditures, operating income, and working capital have to be redefined for these firms.
I begin this book by laying out the facts on the growth of technology and, in particular, new technology stocks in the equity market and argue that although the principles of valuation might not shift, the focus can change as firms move through their life cycles. This discussion is followed by an extended section (Chapters 2-7) on applying traditional discounted cash flow models to value technology stocks, with an emphasis on the estimation of cash flows, growth, and discount rates for these firms. In the next three chapters, I look at the use of relative valuation to value technology companies, both in terms of adapting existing multiples (such as price-earnings and price-to-sales ratios) and developing new ones (value per Web site visitor, for instance). In Chapter 11, "Real Options in Valuation," I consider an argument made by many for the large premiums paid on technology stocks (i.e., they represent real options to expand into a potentially huge e-commerce market), and consider some questions that a skeptic should ask before accepting this argument. In Chapter 12, "Value Enhancement," I consider how managers of technology firms can enhance the value of their firms through better investment and financing decisions.
The book is structured around the valuations of five technology firms-Motorola, Cisco, Amazon, Ariba, and Rediff. The first three are household names but represent three different points in the technology spectrum. Motorola is an old technology firm with substantial investments in existing assets. It is also a firm that has fallen on hard times in the last few years, largely as a consequence of poor investments and strategic choices. Cisco is one of the great success stories of the 1990s, but a great deal of the market value of the firm reflects expectations about the future. It is also a firm that has chosen to grow through acquisitions and has done it very well. Amazon is the poster child (for better or worse) for the new economy stocks that have entered the market in recent years, and the popular press has documented its ups and downs in extensive detail. Ariba and Rediff are more recent entrants into the new economy, with Ariba representing the promise (and peril) of the Business-to-Business (B2B) Internet model, and Rediff the potential of an Internet portal serving a market (India) that could be a huge market in the future.
One of the limitations of valuing real companies is that your mistakes are there on the printed page for all to see over time, but that prospect does not bother me. At the risk of giving away the punch line, I do find discounted cash flow values for all five companies: Motorola ($32.39), Cisco ($44.92), Amazon ($34.37), Ariba ($72.13), and Rediff ($19.05). For what it is worth, at the time that I did the valuations in June 2000, I found Amazon to be overvalued at $48 per share and Cisco to be overvalued at $64.88. Motorola at $34.25 per share and Ariba at $75 per share were fairly valued, and Rediff was significantly undervalued at $10 per share. By the time I finished the book, Amazon had dropped in value to $30 per share, and Cisco was trading at $51. Motorola had gone from being fairly valued to undervalued, Ariba saw its stock price double, and Rediff remained undervalued. I have no doubt that you will disagree with me on some of the inputs I have used, and the values that you assign these firms will be different from mine. What I would emphasize, therefore, is not the values that I arrive at for these firms, but the process by which I got there.
Finally, I want this book to be useful to a wide audience: individual investors who hold technology stocks in their portfolios, equity research analysts, venture capitalists, and managers at technology firms. There are portions of the book that I must confess are not easy reading, but I have tried as much as I can to provide an intuitive rationale for everything that I do. Technology firms, notwithstanding the back and forth of markets, are here to stay, and valuing them is something we all need to grapple with. I hope you find this book useful in that endeavor.
From the Back Cover
- The comprehensive guide to valuing technology companies
- Projections for future revenues, earnings, cash flows, the impact of stock options, and more
- 5 detailed case studies cover the entire tech lifecycle: Amazon.com, Ariba, Cisco, Motorola, and a new IPO
- Presented by one of the world's leading experts in valuation
- State-of-the-art tools for assessing the value of any technology company
Technology companies have exploded in importance, yet investors and analysts face unprecedented challenges in valuing them. In The Dark Side of Valuation, one of the world's leading valuation experts reviews every approach, demonstrating exactly how to adapt traditional techniques to minimize risks and maximize returns.
Aswath Damodaran begins with an overview of the markets' dramatic shift towards technology stocks ? specifically new technology stocks. He then identifies key valuation principles and techniques, demonstrating them through five case studies that encompass the entire technology company lifecycle: Amazon.com, Ariba, Cisco, Motorola, and a new IPO-ready startup. Coverage includes:
- Adaptation of discounted cash flow models for tech companies with limited histories, shifting business mixes, and volatile stock prices
- The limitations of traditional accounting definitions in measuring technology company cash flows
- Superior processes for estimating future revenues, earnings, and cash flows
- Evaluation of the impact of management and employee stock options on share value and earnings multiples
- An in-depth assessment of PEG and price-to sale ratios
- Relative valuation: fundamentals, earnings multiples, and revenue multiples
?Louis Columbus
Director of Marketing, Linksys
About the Author
Aswath Damodaran is Professor of Finance at the Stern School of Business at New York University, where he teaches corporate finance and equity valuation. Damodaran has written two books on equity valuation (Damodaran on Valuation and Investment Valuation), as well as two books on corporate finance (Corporate Finance: Theory and Practice and Applied Corporate Finance: A User's Manual). He also published widely in leading journals of finance, including The Journal of Financial and Quantitative Analysis, The Journal of Finance, The Journal of Financial Economics, and the Review of Financial Studies.
Damodaran received the Stern School of Business Excellence in Teaching Award in 1988, 1991, 1992, and 1999. In 1194, he was profiled in Business Week as one of the top 12 U.S. business school professors. Damodaran holds M.B.A. and Ph.D. degrees from the University of California at Los Angeles. Prior to joining NYU, he served as visiting lecturer at the University of California, Berkley from 1984 to 1986, where he received the Earl Cheit Outstanding Teaching Award in 1985.
Excerpt. © Reprinted by permission. All rights reserved.
Preface
Do the old rules still apply? Do we need new valuation metrics, or are the old metrics flexible enough to deal with the companies that constitute the new economy? Can you value a company that has no earnings, no history, and no comparable firms? These are the questions that I have heard repeatedly over the last few years. I have always believed the fundamentals that determine value are the same, no matter what company you value and what market it is in. Increasingly, though, I have faced skeptical audiences who are unwilling to take this belief at face value and have demanded proof that America Online, Amazon.com, or Priceline.com can be valued with traditional models.
The genesis for this book was a paper I did on valuing Amazon.com in March 2000, where a discounted cash flow model yielded a value of $34 per share. Since the stock was trading at $80 at that time, there were many who viewed the valuation as either excessively pessimistic or as missing something. The interest in the paper led me to think about writing a book, but I expanded it to cover both new technology and old technology firms. While there are differences in estimation that arise across these firms, I believe that they have far more in common. Why technology firms? I believe that traditional valuation books and models (and I count my book on investment valuation among the culprits) have tended to concentrate on valuing manufacturing or traditional service firms. Technology firms are different. They expand by investing in research and through acquisitions and not by building plant and equipment. Many of them have astronomical growth rates in revenues and often, very little in current earnings. Their assets are often patents, technology, and skilled employees. I look at how the notions of capital expenditures, operating income, and working capital have to be redefined for these firms.
I begin this book by laying out the facts on the growth of technology and, in particular, new technology stocks in the equity market and argue that although the principles of valuation might not shift, the focus can change as firms move through their life cycles. This discussion is followed by an extended section (Chapters 2-7) on applying traditional discounted cash flow models to value technology stocks, with an emphasis on the estimation of cash flows, growth, and discount rates for these firms. In the next three chapters, I look at the use of relative valuation to value technology companies, both in terms of adapting existing multiples (such as price-earnings and price-to-sales ratios) and developing new ones (value per Web site visitor, for instance). In Chapter 11, "Real Options in Valuation," I consider an argument made by many for the large premiums paid on technology stocks (i.e., they represent real options to expand into a potentially huge e-commerce market), and consider some questions that a skeptic should ask before accepting this argument. In Chapter 12, "Value Enhancement," I consider how managers of technology firms can enhance the value of their firms through better investment and financing decisions.
The book is structured around the valuations of five technology firms-Motorola, Cisco, Amazon.com, Ariba, and Rediff.com. The first three are household names but represent three different points in the technology spectrum. Motorola is an old technology firm with substantial investments in existing assets. It is also a firm that has fallen on hard times in the last few years, largely as a consequence of poor investments and strategic choices. Cisco is one of the great success stories of the 1990s, but a great deal of the market value of the firm reflects expectations about the future. It is also a firm that has chosen to grow through acquisitions and has done it very well. Amazon.com is the poster child (for better or worse) for the new economy stocks that have entered the market in recent years, and the popular press has documented its ups and downs in extensive detail. Ariba and Rediff.com are more recent entrants into the new economy, with Ariba representing the promise (and peril) of the Business-to-Business (B2B) Internet model, and Rediff the potential of an Internet portal serving a market (India) that could be a huge market in the future.
One of the limitations of valuing real companies is that your mistakes are there on the printed page for all to see over time, but that prospect does not bother me. At the risk of giving away the punch line, I do find discounted cash flow values for all five companies: Motorola ($32.39), Cisco ($44.92), Amazon.com ($34.37), Ariba ($72.13), and Rediff.com ($19.05). For what it is worth, at the time that I did the valuations in June 2000, I found Amazon to be overvalued at $48 per share and Cisco to be overvalued at $64.88. Motorola at $34.25 per share and Ariba at $75 per share were fairly valued, and Rediff.com was significantly undervalued at $10 per share. By the time I finished the book, Amazon had dropped in value to $30 per share, and Cisco was trading at $51. Motorola had gone from being fairly valued to undervalued, Ariba saw its stock price double, and Rediff remained undervalued. I have no doubt that you will disagree with me on some of the inputs I have used, and the values that you assign these firms will be different from mine. What I would emphasize, therefore, is not the values that I arrive at for these firms, but the process by which I got there.
Finally, I want this book to be useful to a wide audience: individual investors who hold technology stocks in their portfolios, equity research analysts, venture capitalists, and managers at technology firms. There are portions of the book that I must confess are not easy reading, but I have tried as much as I can to provide an intuitive rationale for everything that I do. Technology firms, notwithstanding the back and forth of markets, are here to stay, and valuing them is something we all need to grapple with. I hope you find this book useful in that endeavor.
Product details
- ASIN : 013040652X
- Publisher : Ft Pr; 1st edition (January 1, 2001)
- Language : English
- Paperback : 479 pages
- ISBN-10 : 9780130406521
- ISBN-13 : 978-0130406521
- Item Weight : 1.6 pounds
- Dimensions : 6.25 x 1.25 x 9 inches
- Best Sellers Rank: #2,030,853 in Books (See Top 100 in Books)
- #369 in Valuation (Books)
- #1,135 in Business Finance
- #4,506 in Economics (Books)
- Customer Reviews:
About the author

Aswath Damodaran is a professor of finance and David Margolis teaching fellow at the Stern School of Business at New York University. He teaches the corporate finance and equity valuation courses in the MBA program. He received his MBA and PhD from the University of California at Los Angeles. His research interests lie in valuation, portfolio management, and applied corporate finance. He has been published in the Journal of Financial and Quantitative Analysis, the Journal of Finance, the Journal of Financial Economics, and the Review of Financial Studies. He has written three books on equity valuation (Damodaran on Valuation, Investment Valuation, and The Dark Side of Valuation) and two on corporate finance (Corporate Finance: Theory and Practice, Applied Corporate Finance: A User's Manual). He has coedited a book on investment management with Peter Bernstein (Investment Management) and has written a book on investment philosophies (Investment Philosophies). His newest book on portfolio management is titled Investment Fables and was published in 2004. He was a visiting lecturer at the University of California, Berkeley, from 1984 to 1986, where he received the Earl Cheit Outstanding Teaching Award in 1985. He has been at NYU since 1986 and received the Stern School of Business Excellence in Teaching Award (awarded by the graduating class) in 1988, 1991, 1992, 1999, 2001, and 2007, and was the youngest winner of the University-wide Distinguished Teaching Award (in 1990). He was profiled in Business Week as one of the top 12 business school professors in the United States in 1994.
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Damodaran is a gifted teacher and in his books is able as well to explain the concepts and techniques of valuation in an understandable manner. The book serves mainly for readers who want to get a comprehensible (and to a certain degree comprehensive) overview of the topics with selected in-depth discussions and it is quite 'readable'.
The Cons:
The book is not new at all, as about 90% is a copy of his earlier book 'Investment Valuation'. The only real difference is the selection of the examples used and the financial and market data are more current compared to his other book from 1994. It seems that the marketing department of the publisher saw an opportunity to sell a 'new' book to the new class of technology investors. However, the occasional comments of which valuation topics are specific to technology companies could be summarized on a couple of pages.
The book is good for giving a comprehensible overview but does not go very much into depth.
Effectively, it's the earlier book 'Investment Valuation' recycled with a new title and new cover, still a good book but not new at all.
As for the reviewer who compained that Damodaran doesn't do enough work in real option theory: Damodaran says in this book exactly what needs to be said about real option theory: that it has very limited applications (which is not to say that it is not revolutionary within those limited applications) and that the push to broaden the use of real option valuation beyond its traditional applications can more often than not constitute misuse and abuse of the models. Not every investment contains options, and not all of those options have value, to paraphrase Damodaran himself. Damodaran doesn't ignore real options, of course: he calls them contingency claims (as they technically should be called) and dedicates a chapter to explaining there use and abuse. Using real options, when it comes down to it, involves building and solving partial differential equations based on stochastic processes. As any actuary or financial analyst could confirm, teaching stochastic processes presupposes a very strong math base and still would require an entire book. Damodaran did the right thing by limiting himself to a single, illustrative chapter.
The best part of this book is that thanks to Damodaran's congenial and accessible ability to write, this book can be read and prove valuable to people with a variety of needs. As an MBA student this book has been invaluable. But I even gave this book as a gift to my brother, a decidedly non-financial person, to replace his countless "How to Invest" books sitting on his bookshelf.
You may want to browse this book before buying. Maybe it'll suit you more than it did me. It appears that the entire manuscript is available on the author's webpage. Personally I prefer the books: Free Cash Flow by Georg Christy and something like Analysis for Financial Management by Robert Higgins.
PS: This review is for the 1st edition from 2001. The new edition may or may not be better.