Valuation analysts spend way too much time tweaking the cost of capital and not enough time on cash flows and earnings, says Professor Aswath Damodaran (New York University Stern School of Business). He reiterates this point in his newly released data posts and datasets updated for 2017 related to valuation and the cost of capital, including historical stock returns, implied equity risk premiums, country risk premiums, and more. All of his commentary and data (with more to come) is available free on his blog that also includes several video presentations about the updates.
“When your valuations go awry, it is almost never because of the mistakes that you made on the discount rate and almost always because of errors in your estimates of cash flows (with growth, margins and reinvestment),” he writes. Therefore, you should focus on making the most accurate cash flow projections possible and include all risks, instead of “obsessing about the minutiae of discount rates.”
In a hurry? When time is of the essence (and when is it not?), Damodaran’s method for valuing an average risk public company in U.S. dollars is to use an 8% cost of capital (his graph shows a global median of 8.03%). If he has time, he will go back and adjust the rate. “If it is a very risky firm, I will start off with a 10.68% cost of capital (the 90th percentile) and again revisit that number, if I have the time,” he says.
Whether or not you agree with his views, we urge all valuation experts to read his insightful commentary and keep an open mind. Also, it’s important to be prepared for possible critiques to your own conclusions.