The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies

The Dark Side of Valuation: Valuing Old Tech, New Tech, and New Economy Companies

by Aswath Damodaran

ISBN-10: 013040652X

ISBN-13: 9780130406521

Pub. Date: 02/06/2001

Publisher: FT Press

  • The comprehensive guide to valuing technology companies
  • Projections for future revenues, earnings, cash flows, the impact of stock options, and more
  • 5 detailed case studies cover the entire tech lifecycle:, Ariba, Cisco, Motorola, and a new IPO
  • Presented by one of the world's leading experts in valuation
  • State-of-the-art

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  • The comprehensive guide to valuing technology companies
  • Projections for future revenues, earnings, cash flows, the impact of stock options, and more
  • 5 detailed case studies cover the entire tech lifecycle:, Ariba, Cisco, Motorola, and a new IPO
  • Presented by one of the world's leading experts in valuation
  • State-of-the-art tools for assessing the value of any technology company

Technology companies have exploded in importance, yet investors and analysts face unprecedented challenges in valuing them. In The Dark Side of Valuation, one of the world's leading valuation experts reviews every approach, demonstrating exactly how to adapt traditional techniques to minimize risks and maximize returns.

Aswath Damodaran begins with an overview of the markets' dramatic shift towards technology stocks — specifically new technology stocks. He then identifies key valuation principles and techniques, demonstrating them through five case studies that encompass the entire technology company lifecycle:, Ariba, Cisco, Motorola, and a new IPO-ready startup. Coverage includes:

  • Adaptation of discounted cash flow models for tech companies with limited histories, shifting business mixes, and volatile stock prices
  • The limitations of traditional accounting definitions in measuring technology company cash flows
  • Superior processes for estimating future revenues, earnings, and cash flows
  • Evaluation of the impact of management and employee stock options on share value and earnings multiples
  • An in-depth assessment of PEG and price-to sale ratios
  • Relative valuation: fundamentals, earnings multiples, and revenue multiples
"What a refreshing book to read! Damodaran's book is essential if capital markets are going to accurately gauge the contributions of emerging companies...His insights are illuminating and his mastery of financial analysis is unmatched."

—Louis Columbus Director of Marketing, Linksys

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Product Details

FT Press
Publication date:
Product dimensions:
6.23(w) x 9.23(h) x 0.96(d)

Table of Contents

1. The Dark Side of Valuation.

Definition of a Technology Firm. The Shift to Technology. Old Tech to New Tech. Extension of the Valuation Metrics. The Implications for Valuation. New Paradigms or Old Principles: A Life Cycle Perspective. Illustrative Examples. Summary. Endnotes.

2. Show Me the Money: The Fundamentals of Discounted Cash Flow Valuation.

Discounted Cash Flow Value. Valuing an Asset with Guaranteed Cash Flows. Introducing Uncertainty into Valuation. Valuing an Asset with Default Risk. Valuing an Asset with Equity Risk. Valuing an Asset with Equity Risk and Finite Life. Valuing an Asset with an Infinite Life. Equity and Firm Valuation. Dividends and Equity Valuation. A Broader Measure of Cash Flows to Equity. From Valuing Equity to Valuing the Firm. Valuing Technology Stocks. Estimated Cash Flow to the Firm. Expected Growth. Discount Rate. Asset Life. Bringing It All Together. Summary. Endnotes.

3. The Price of Risk: Estimating Discount Rates.

Cost of Equity. Risk and Return Models. Estimation Issues. From Cost of Equity to Cost of Capital. Calculating the Cost of Debt. Calculating the Cost of Hybrid Securities. Calculating the Weights of Debt and Equity Components. Estimating the Cost of Capital. Summary. Endnotes.

4. Cash is King: Estimating Cash Flows.

Defining the Cash Flow to the Firm. Operating Earnings (EBIT). Updated Earnings. Adjustments to Operating Earnings. The Tax Effect. Effective versus Marginal Tax Rate. The Effect of Net Operating Losses. The Tax Benefits of R&D Expensing. Reinvestment Needs. Net Capital Expenditures. Noncash Working Capital Investments. Summary. Endnotes.

5. Looking Forward: Estimating Growth.

The Importance of Growth. Growth Assets and Assets in Place. Growth Assets at Technology Firms. Historical Growth. Estimating Historical Growth. The Usefulness of Historical Growth. Historical Growth at Technology Firms. Analyst Estimates of Growth. Number of Analysts Following Technology Firms. The Quality of Earnings Forecasts. The Fundamental Determinants of Growth. Scenario: Stable Return on Capital. Scenario: Positive and Changing Return on Capital. Scenario: Negative Return on Capital. The Qualitative Aspects of Growth. The Question of Detail. Summary. Endnotes.

6. Estimating Firm Value.

Closure in Valuation. Multiple Approach. Liquidation Value. Stable Growth Model. Valuing Operating Assets. The Survival Issue. Life Cycle and Firm Survival. Likelihood of Failure and Valuation. Cash and Nonoperating Assets. Cash and Marketable Securities. Holdings in Other Firms. Other Nonoperating Assets. Firm Value and Equity Value. Summary. Endnotes.

7. Management Options, Control, and Liquidity.

Management and Employee Options. The Magnitude of the Option Overhang. Options in Existence. Future Option Grants. Value of Control. Voting Shares versus Nonvoting Shares. Valuing Control. Control in Private Businesses. Value of Liquidity. Determinants of Illiquidity Discount. Quantifying the Liquidity Discount. Liquidity Discounts at Publicly Traded Firms. Summary. Endnotes.

8. Relative Valuation.

Use of Relative Valuation. Reasons for Popularity. Potential Pitfalls. Standardized Values and Multiples. Earnings Multiples. Book Value or Replacement Value Multiples. Revenue Multiples. Sector-Specific Multiples. The Four Basic Steps to Using Multiples. Definitional Tests. Descriptional Tests. Analytical Tests. Application Tests. Reconciling Relative and Discounted Cash Flow Valuations. Summary. Endnotes.

9. Earnings Multiples.

Price-Earnings Ratio (PE). Definitions of PE Ratio. Cross-Sectional Distribution of PE Ratios. Determinants of the PE Ratio. Using the PE Ratio for Comparisons. The PEG Ratio. Definition of the PEG Ratio. Cross-Sectional Distribution of the PEG Ratio. Determinants of the PEG Ratio. Using the PEG Ratio for Comparisons. Other Earnings Multiples. Price to Future Earnings. Price to Earnings Before R&D Expenses. Enterprise Value to EBITDA. Summary. Endnotes.

10. Other Multiples.

Revenue Multiples. Definition of Revenue Multiple. Cross-Sectional Distribution. Analysis of Revenue Multiples. Using Revenue Multiples in Analysis. Multiples of Future Revenues. Sector-Specific Multiples. Definitions of Sector-Specific Multiples. Determinants of Value. Analysis with Sector-Specific Multiples. Summary. Endnotes.

11. Real Options in Valuation.

Basics of Option Pricing. Call Options: Description and Payoff Diagrams. Put Options: Description and Payoff Diagrams. Determinants of Option Value. American versus European Options: Variables Relating to Early Exercise. Option Pricing Models. A Few Caveats on Applying Option Pricing Models. Barrier, Compound, and Rainbow Options. The Option to Delay. The Payoff Diagram on the Option to Delay. Valuing the Option to Delay. Practical Considerations. Implications for Project Analysis and Valuation. Valuing a Patent. From Patent Value to Firm Value. The Option to Expand. Practical Considerations. Implications for Valuation. When Are Real Options Valuable? Some Key Tests. Quantitative Estimation. Key Tests. Summary. Endnotes.

12. Value Enhancement.

Value Creation: A Discounted Cash Flow (DCF) Perspective. Value-Creating and Value-Neutral Actions. Ways of Increasing Value. The Value Enhancement Chain. Alternatives to the Traditional Valuation Model. Economic Value Added. Cash Flow Return on Investment. Summary. Endnotes.

13. A PostScript.

Fundamentals Don't Change. Cash Flow, Growth, and Risk. Lessons for Investors. Lessons for Managers. Grow, Grow, Grow? Growth and Value. Lessons for Investors. Lessons for Managers. The Expectations Game. Expectations, Information, and Value. Lessons for Investors. Lessons for Managers. Live with Noise. Noise in the Valuation of Technology firms. Implications for Investors. Implications for Managers. Summary. Endnotes. References.


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