Equity Valuation: Models from Leading Investment Banks

Foreword

Every student of finance or applied economics learns the lessons of Franco Modigliani and Merton Miller. Their landmark paper, published in 1958, laid out the basic underpinnings of modern finance and these two distinguished academics were both subsequently awarded the Nobel Prize in Economics. Simply stated, companies create value when they generate returns that exceed their costs. More specifically, the returns of successful companies will exceed the risk-adjusted cost of the capital used to run the business. Further, these returns and the securities of the underlying companies must be judged against an uncertain backdrop, such that the risk-adjusted expected returns are attractive.

Investors seek to identify these successful companies. They strive to calculate the appropriate pricing of securities. How can this best be done? Every practitioner knows that the two simple declarative sentences at the beginning of this paragraph belie the complexity of the search for successful companies and financial instruments that offer favorable prospects for investors. The world is messier than models. Accounting data can be unreliable, economic conditions can change, investor risk tolerance can shift, and low-probability scenarios can occur.

This book is written from the perspective of practitioners, and the editors have chosen leaders in the field who can describe the theory and implementation behind their various approaches. The contributors to Equity Valuation: Models from Leading ...