The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit (Little Books. Big Profits)

by Aswath Damodaran

In both discounted cash flow and relative valuation, we build in our expectations of what success will look like in terms of revenues and earnings. Sometimes, success in one business or market can be a stepping-stone to success in other businesses or markets. Success with an existing product can sometimes provide an opening for a firm to introduce a new product. The success of the iPod laid the foundations for the introduction of the iPhone and the iPad for Apple. Companies that succeed with a product in one market may be able to expand into other markets with similar success. The most obvious example of this is expanding into foreign markets to build on domestic market success, a pathway adopted by companies like Coca Cola, McDonald’s, and many retail companies. The more subtle examples are products that are directed at one market that serendipitously find new markets: An ulcer drug that reduces cholesterol would be a good example. Why cannot we build expectations about new products and new markets into our cash flows and value? We can try, but there are two problems. First, our forecasts about these potential product and market extensions will be very hazy at the time of the initial valuation and the cash flows will reflect this uncertainty. Apple would not have been able to visualize the potential market for the iPhone at the time that they were introducing the iPod. Second, it is the information gleaned and the lessons learned during the initial product launch and subs...