Books like The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit

The Little Book of Valuation by Aswath Damodaran gives comprehensive overview of factors that needs to be taken into account for valuation of a company while investing. The book gives immense value in terms of understanding valuation of a company.Value investing is the discipline of buying securities at significant discount from their current values and holding them until more of their values is realized. Valuing a company/business is the most important aspect of investing. It’s a daunting task. The complexities/variables involved in business are enormous. While precision is a good measure of process in mathematics or physics, it is poor measure of quality in valuation. It's better to be vaguely right then precisely wrong while valuing a company.There are far many uncertainties involved in valuation. Macroeconomic factors, regulations, interest rate, competition, innovation these things cannot be predicted with accuracy. Even if one can accurately predict macroeconomic factors, there are far too many other factors/variables involved. Therefore, its aptly said that success in investing comes not from being right but from being wrong less often than everyone else. Understanding valuation is critical to be an informed and successful investor instead of being a speculator focusing merely on price fluctuations. Basically there are two approaches for valuation i.e. Intrinsic and relative. In intrinsic valuation, the value of an asset is determined by the cash flows that one expects to generate over its life and how uncertain one feel about the cash flows. Assets with high and stable cash flows should be more valuable than assets with low and volatile cash flows. In relative valuation assets are valued by looking at how the market prices similar assets. It’s like while determining what to pay for a house, one looks at what similar houses in the neighborhood sold for. With a stock it means comparing its prices to similar stocks in its peer group. Both the approaches i.e. intrinsic as well as relative valuation plays a critical role in picking a sound stocks.Valuing growth companies requires a different approach as compared to valuing a mature company with substantial market size. Both scale and competition conspires to lower growth rates quickly at even the most promising growth companies. Various valuation matrices can be used i.e. Book value, Earnings Price Ratio, Price to Book Value, Price Earnings Growth ratio, Return on Invested Capital to understand valuation of a company. These figures give sense about the quantitative aspect of valuing a business, whereas qualitative aspects of valuing a business i.e. quality of the management are much difficult to assess. The quality of the management is also critical as the management directly controls the company not the shareholders.Also one needs to be aware of cognitive biases in the market. With professional analysts, there are institutional factors that add to substantial bias. Equity research analyst issue more buy than sell recommendations. It’s important to do background research on the company to information sources rather than opinion sources. One should spend more time looking at a company’s financial statements than reading equity research reports about the company. Psychological studies have shown that a loss hurts twice as much as a gain of the same amount makes us happy as people gets hurt losing money much more than they enjoy making money. It leads to panic sales of selling low because investors sell in fear that the stock market will fall more. But for a value investor who is aware of such psychological factors will use it to buy value stocks at bargain price/ extremely cheap price. Therefore, it's important to understand this loss aversion theory as well as the prospect theory.It is also important to understand the difference between volatility and risk. Volatility is price fluctuations whereas risk is business fluctuations. By focusing on keeping the risk minimal, one can find investment that have low or even no risk and offer extremely positive returns. Volatility is a friend of the value investors, understanding of risk and volatility will lead to better investing decision.It's important to understand the book value, liquidation value, intrinsic value etc. Intrinsic value is different from book value. The change in the book value in one year or over a period of time tells how much the intrinsic value of the business has changed. Return on investment capital is also extremely important to factor in a business that manages to compound its capital at a high return will definitely do well over a long period of time. The margin of safety in terms of both price as well as business is also extremely important.The Little Book of Valuation by Aswath Damodaran is an insightful book, very much recommended for anyone learning investing.