The Little Book of Valuation

If you accept the Markowitz proposition that the only risk you care about is the risk that you cannot diversify away, how do you measure the exposure of a company to this market-wide risk?

The macroeconomic risk that affects many or most firms cannot be diversified away. In the Markowitz world, this market risk is the only risk that you should consider, as an investor in a publicly traded company.

The discount rate can be viewed as a composite of the expected real return (reflecting consumption preferences), expected inflation (to capture the purchasing power of the cash flow), and a premium for uncertainty associated with the cash flow.

Success in investing comes not from being right but from being wrong less often than everyone else.

Cash flows that are riskier should be assessed a lower value than more stable cash flows.

The intrinsic value of an asset is determined by the cash flows you expect that asset to generate over its life and how uncertain you feel about these cash flows.

The key lesson from this distribution should be that using the average as a comparison measure can be dangerous with any multiple. It makes far more sense to focus on the median.

Assets with high and stable cash flows should be worth more than assets with low and volatile cash flows. You should pay more for a property that has long-term renters paying a high rent than for a more speculative property with not only lower rental income, but more variable vacancy rates from period to period.

In conventional discounted cash flow valuation models, we use higher discount rates on riskier cash flows and lower discount rates on safer cash flows.