Valuation Wednesday: what is valuation? What is price?
And what do you do when they diverge?
|Tony Sheng||Jul 17, 2019|| 1|
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Welcome to the first edition of Valuation Wednesday, where I share out some notes and thoughts from Aswath Damodaran’s Valuation course.
I’m not sure how this will work yet, but I think it’ll probably look something like this:
I’ll define a range of course material that the post covers
And expound on a few points I found particularly interesting, drawing some examples from my experiences in crypto
So if you want to learn the thing yourself, you’ll want to review the course materials I link. And if you just want bits and pieces, you can just read my posts.
Okay let’s give this a try.
What is valuation? What is price?
Valuation is the craft of finding the value of an asset. Everything from companies to baseball cards has a value. You just have to find it.
It’s a practical craft, not a theoretical one. And in practice, valuation is either used to identify mispriced assets (an inefficient market) or justify market prices (an efficient market).
This point is important to understand, and something I’ve written about previously.
As Damodaran notes, “one of the most common misconceptions in valuation is that we often use the word ‘value’ when we mean the word ‘price.’” This section of his lecture is worth listening to.
Price equals value in an efficient market. But in an inefficient market like today’s altcoins, a valuation on a given coin will expose a market inefficiency. The value will differ from the price.
Acting on your estimated valuation assumes two things about the market:
That it will become more efficient
That it will become more efficient on a relevant time frame for your investment
A lot of digital asset investors don’t think enough about these two assumptions. Some come up with what the value should be and then expect the market to return to that value (assuming the market will be efficient). And even if they are correct about assumption one, sometimes they don’t think enough about timing. As Keynes once said, “the market can stay irrational longer than you can stay solvent.”
Value is what the price should be in an efficient market
Price is what people are willing to pay for a thing and things similar to it
In an inefficient market, value and price will diverge. If and how you capitalize on that divergence depends on your assumptions about whether the market will return to rationality and if so, when.
Prior editions (in chronological order):