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5 Directions for future research.

As we survey the research done on valuation in the last few decades, there are three key trends that emerge from the research. First, the focus has shifted from valuing stocks through models such as the dividend discount model to valuing businesses, representing the increased use of valuation models in acquisitions and corporate restructuring (where the financing mix is set by the acquirer) and the possibility that financial leverage can change quickly over time. Second, the connections between corporate finance and valuation have become clearer as value is linked to a firm's actions. In particular, the excess return models link value directly to the quality of investment decisions, whereas APV models make value a function of financing choices. Third, the comforting conclusion is that all models lead to equivalent values, with consistent assumptions, which should lead us to be suspicious of new models that claim to be more sophisticated and yield more precise values than prior iterations.

The challenges for valuation research in the future lie in the types of companies that we are called upon to value. First, the shift of investments from developed markets to emerging markets in Asia and Latin America has forced us to re-examine the assumptions we make about value. In particular, the interrelationship between corporate governance and value, and the question of how best to deal with the political and economic risk endemic to emerging markets have emerged as key topics. Second, the entry of young companies into public markets, often well before they have established revenue and profit streams, requires us to turn our attention to estimation questions: How best do we estimate the revenues and margins for a firm that has an interesting product idea but no commercial products? How do we forecast the reinvestment needs and estimate discount rates for such a firm? Third, with both emerging market and young companies, we need to reassess our dependence on current financial statement values as the basis for valuation. For firms in transition, in markets that are themselves changing, we need to be able to allow for significant changes in fundamentals, be they risk parameters, debt ratios and growth rates, over time. In short, we need dynamic valuation models rather than the static ones that we offer as the default currently. Fourth, as the emphasis has shifted from growth to excess returns as the driver of value, the importance of tying corporate strategy to value has also increased. After all, corporate strategy is all about creating new barriers to entry and augmenting or preserving existing ones, and much work needs to be done at the intersection of strategy and valuation. Understanding why a company earns excess returns in the fist place and why those excess returns may come under assault is a pre-requisite for good valuation. Finally, while the increase in computing power and easy access to statistical tools has opened the door to more sophisticated variations in valuation, it has also increased the potential for misuse of these tools. Research on how best to incorporate statistical tools into the conventional task of valuing a business is needed. In particular, is there a place for simulations in valuation and if so, what is it? How about scenario analysis or neural networks? The good news is that there is a great deal of interesting work left to be done in valuation. The bad news is that it will require a mix of interdisciplinary skills including accounting, corporate strategy, statistics, and corporate finance for this research to have a significant impact.

Aswath Damodaran

Stern School of Business, New York University, 44 W. 4th Street, 9th Floor, New York, NY 10012-1126,
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Title Annotation:Valuation Approaches and Metrics: A Survey of the Theory and Evidence
Author:Damodaran, Aswath
Publication:Foundations and Trends in Finance
Date:Mar 1, 2006
Previous Article:4 Relative valuation.
Next Article:6 Conclusion.

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