Friday, August 31, 2012

Valuation Techniques

Investing ultimately comes down to the ability of an individual to value a company and the associated risks of such a valuation. There are hundreds of different models and techniques in use today, both simple ones devised by humans and enormously complex ones used in algorithmic trading.

I don't believe that there is one magic, all-encompassing, algorithm that will perform optimally in all (or even most) scenarios. The issue is that every company has a different business model, each of which would require a different model for valuation. This task is rather intractable, and so it is the job of the investor to be able to create robust models that hold under reasonable approximations. In addition, he must be able to understand which approximations hold for which businesses, and use the appropriate model.

Many present models involve looking at one aspect of a business, such as dividends, cash flow, earnings, etc. From these, you can derive dividend discount model, discounted cash flow, and P/E relative valuations, respectively. But naturally, these are rather crude in the sense that they don't look at all of the variables. And combining different valuation schemes is a non-trivial process.

In this series of articles, I will start with a set of assumptions and derive some models for valuation using these approximations. This post will be edited as articles are added.
  1. Liquidation value
  2. Dividend Discount Model

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Obligatory Disclaimer

The author is not qualified to give financial, tax, or legal advice and disclaims any and all liability for this information.