Damodaran on Valuation

Chapter 5. Equity Discounted Cash Flow Models

In the three preceding chapters, we considered the basic principles governing the estimation of discount rates and cash flows. In the process, we drew a distinction between valuing the equity in a business and valuing the entire business. In this chapter, we turn our attention to discounted cash flow (DCF) models that value equity directly.

The first models examined take a strict view of equity cash flows and consider only dividends to be cash flows to equity. These dividend discount models (DDMs) represent the oldest variant of discounted cash flow models. While abandoned by many analysts as old-fashioned, they are still useful in a wide range of circumstances. We then consider broader definitions of cash flows to equity, by first including stock buybacks in cash flows to equity and by then expanding our analysis to cover potential dividends or free cash flows to equity. We close the chapter by examining why the different approaches may yield different values for equity per share.