As mentioned in part one of this review, this is a book that covers much more than valuation, giving an introduction to corporate finance and investment issues as well as valuation over the corporate life cycle. Given this scope, inevitably, the specific valuation content is less comprehensive than if the entire book covered only valuation (for example, Damodaran explains the concepts behind the cost of capital but does not show how to calculate a particular cost of capital). The book includes valuation (and pricing) case studies with extensive commentaries for companies in each stage of the life cycle.

Damodaran uses a discounted cash flow valuation approach throughout the book to arrive at companies’ overall intrinsic values, emphasising the relative importance of particular inputs when a company is at different stages of the life cycle.

He advocates using five valuation inputs so that the value drivers can be easily understood: revenue growth, operating margins, operating efficiency (the returns expected from new investment), the risk-adjusted discount rate and an estimate of the likelihood of failure (this is for companies other than those in financial services and real estate which have different value drivers). He emphasises the importance of understanding the company’s expected prospects (its story), as well as its financial results, to estimate these inputs. The numbers and the narrative are used together to give the intrinsic value of the equity.

Damodaran acknowledges that others use different methods, such as venture capitalists who often apply a high discount rate to take into account the many and varied risks (including that of business failure) in a start-up valuation; he argues that his more detailed discounted cash flow approach, looking at the various different inputs over a forecast period, gives a better valuation estimate.

In contrast to valuation, Damodaran considers pricing to be driven by mood and momentum, incremental information available to the market, groupthink, and liquidity and trading ease. Nevertheless, he looks carefully at pricing in his text and case studies, considering the particular issues that arise at each stage in a company’s life cycle, including the difficulties in finding appropriate priced peers, choosing metrics (such as earnings or revenues) to compare companies, and controlling for differences between the companies. At relevant points he also considers matters such as control premia and sum of the parts valuations.

Regardless of the stage in the corporate life cycle, Damodaran uses the following valuation framework, and he provides discounted cash flow case studies of companies at different stages in the corporate life cycle to illustrate the steps:

• Specify or update your valuation story for the company, based on your knowledge of it;
• Ensure that the business passes the 3P test, that is that success is possible, plausible and probable;
• Estimate the valuation inputs (revenue growth, margins, reinvestment, risk and probability of failure) for the valuation model based on the valuation story;
• Run the valuation model to give a valuation for the company and consider how to deal with the most significant uncertainties; and
• Consider what additional support can be found for the principal assumptions by contacting people involved in the company’s industry and (potential) market.

This book shows how to apply the discounted cash flow approach in case studies of valuations of companies at each of Damodaran’s different stages of the corporate life cycle. However, it is about more than valuation and its strength is in bringing together analysis of financing, valuation and investing across the business life cycle. It is a thoughtful book that provides data and frameworks for each of these areas, providing an introduction to valuation across the life cycle and showing how valuation fits into a company’s story.

^{*The views expressed are the author’s and not ICAEW’s}