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Valuation is an art, not a science

While valuations are taught in schools using the mathematical formula of present value of future cash flows, estimation of those future cash flows involves huge assumptions and subjectivity. And the beauty of scientific formulae lies in its inputs as the value of output is as good as that of input or GIGO.

 

Using financial ratios, one cannot just say that a lower multiple is better since it can be a value trap. A stock may command a premium due to a variety of factors, including but not limited to growth, balance sheet strength, and management quality.

 

Combining important financial aspects, making assumptions on key variables, and choosing a valuation methodology allows one to create a picture, called outlook, which must be analysed through the lens of market expectations. One learns with experience after several interpretations.

 

The entire framework involves judgements, which can never have a 100% success ratio, and a resulting outlook is constantly assessed in the court of the stock market, which then proves one right or wrong every day. One just needs to be right more often than wrong!

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