A simple matrix allows you to quickly value any asset.
It can't tell the full story, but efficiently directing your efforts will save massive time and get you immediately focused on what matters.
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The valuation methods to pick and choose by asset class:
- 1) Discounted-Cash-Flow*
Any asset with clear value capture, a bounded range of outcomes, and investing style long enough to realize that value.
- 2) Price-to-Earnings*
Ultimately a DCF proxy in the following way:
Oversimplifying, the terminal value of a DCF = profit level divided by: the discount rate minus the long term growth rate.
The discount rate minus the growth rate determines the 'terminal multiple.'
E.g. if you think profitability grows 3%/yr and use a discount rate of 10%, the multiple is: 1 / (10%-3%) = a 14x multiple.
Using a P/E instead of a DCF simply uses next year as the terminal value.
In many cases, most of the value is in the terminal multiple anyway, so a P/E shortcuts that process.
- 3) EV-to-EBITDA*
Same concept, but replacing terms that apply to the EV not just the equity.
- 4) Price-to-Revenue*
All performance ratios are ultimately proxies/shortcuts for DCFs.
But in practice, often the conditions cited above don't exist yet.
Price-to-revenue applies where there is not yet steady profitability, but there is enough clarity on revenue growth and bounded LT margin range.
- 5) Asset Coverage*
For credit investing or other situations where there is tangible asset value underlying the investment.
- 6) Correlations / Pure Comparison*
Macro variables, currencies, commodities, products, art, and others are often are priced simply as a function of their relationship to other major similar or analogous assets.
- 7) Marginal Cost (sometimes plus ROIC)*
Commodities in oversupply price to the marginal cost of production.
More subtly, a similar construct applies to goods, services, FX, and other semi-commoditized markets.
- 8) Marginal Utility*
Commodities in scarcity price to the marginal utility.
- 9) Value-per-User*
Similar to price-to-revenue, a leading/proxy DCFs shortcut.
- 10) TAM capture*
Also a several-steps-removed DCF shortcut.
- 11) Team / Value Creation*
Can a team add value separate from current fundamentals.
- 12) Theoretical Models*
Included for completeness, usually less practical.
A prominent one in FX (and certain digital assets) is MV = PQ which relates money supply, velocity, and real activity levels to price levels.
The takeaway is that while there is not a single provably correct valuation answer, there are many wrong ones.
The key is to quickly direct your focus to what matters, and then to drill down as far as you can to pursue truth in that direction.
That's all for now.
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