Damodaran on Valuation

7.3. REASONS FOR POPULARITY AND POTENTIAL PITFALLS

Why is the use of relative valuation so widespread? Why do managers and analysts relate so much better to a value based on a multiple and comparables than to discounted cash flow valuation? In this section, we consider some of the reasons for the popularity of multiples.

• Use of multiples and comparables is less time and resource intensive than discounted cash flow valuation. Discounted cash flow valuations require substantially more information than relative valuation. For analysts who are faced with time constraints and limited access to information, relative valuation offers a less time-intensive alternative.

• It is easier to sell. In many cases, analysts in particular and salespeople use valuations to sell stocks to investors and portfolio managers. It is far easier to sell a relative valuation than a discounted cash flow valuation. After all, discounted cash flow valuations can be difficult to explain to clients, especially when working under a time constraint—many sales pitches are made over the phone to investors who have only a few minutes to spare for the pitch. Relative valuations, in contrast, fit neatly into short sales pitches. Using political terminology, it is far easier to spin a relative valuation than it is to spin a discounted cash flow valuation.

• It is easier to defend. Analysts are often called upon to defend their valuation assumptions in front of superiors, colleagues, and clients. Discounted cash flow valuations, ...