“A great deal of what passes for valuation in corporate board rooms, investment banks, and portfolio management is pricing, not valuation, and the evidence is clear, especially with Facebook,” writes Aswath Damodaran (NYU Stern School of Business) in his recent blog, Musings on Markets. On May 23, for example, the professor listed the hallmarks of a “pricer” versus a “valuer”:
Pricing is an exercise of gauging demand and supply, reading investor moods and determining what people will pay for an asset, rather than what it is worth. Valuation is about estimating what an asset is worth, given its earning potential, growth and risk. You can tell whether an investor or analyst is a “pricer” or “valuer” by looking at the tools that he or she uses. The tools of choice for most pricers are relative valuation (multiples such as PE or EV multiples), [which] assess how much you will pay for an asset by looking at what others are paying for similar assets (usually other companies in the same business), and technical analysis (where you use charts and indicators to gauge shifts in demand). The tools of choice for “valuers” are either discounted cash flow (DCF) or accounting-based (building off book value) models.
In the weeks leading up to the IPO, an “army of banks” (led by Morgan Stanley) developed an “offering” price for Facebook, Damodaran adds. “While I am sure that there was an intrinsic valuation done somewhere along the way, I will also wager that it was done to preserve appearances and that it had little or nothing to do with the price that was eventually set.” To set that price, the banks most likely used two variables: the prices at which investors were transacting in the private market for FB shares (in the mid-40s) and what institutional investors indicated they would be willing to pay. Much of the background “chatter” was also framed in terms of pricing, Damodaran says, with the optimists arguing that FB was trading at less than other social media companies and the pessimists saying it was trading at much higher multiples of earnings or revenues than Google or Apple. “Any attempt at full-fledged valuation, where you confronted the uncertainty and attempted to make estimates, was viewed as an exercise in speculation and guesswork.”
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