Damodaran on Valuation

Part II: Relative Valuation

In relative valuation, we value assets based on how similar assets are priced. We begin this section, in Chapter 7, by noting that most valuations in practice are relative valuations and present reasons for the allure of this approach. Since it is pointless to argue against relative valuation, we present a four-step process to use multiples correctly and to detect when they are being misused.

In Chapter 8, we look at equity multiples, starting with price-earnings (P/E) ratios. After presenting the many versions of P/E ratio that we see in practice, we examine their statistical properties and the determinants. We then apply them to value individual firms in sectors and broaden the application to look at the entire market. We do the same with price-earnings/growth (PEG) ratios, price-to-book ratios, and price-to-sales ratios.

In Chapter 9, we look at firm value and enterprise value multiples and apply the same techniques we used with P/E ratios. After sifting through different definitions of commonly used multiples (like EV/EBITDA), we consider their determinants and the key questions we need to be asking about firms that are valued using these multiples. We also look at ways in which we can extend relative valuation to value young or distressed money-losing companies.