The Little Book of Valuation: A Practical Review
The man who literally wrote the textbook on valuation also wrote the short version. Two methods, both legible to a normal human. One of them quietly does most of the heavy lifting.
DCF vs relative valuation, side by side
| Method | How it works | Strength | Weakness |
|---|---|---|---|
| DCF | Forecast cash flows, discount to today | First-principles intrinsic value | Heavy assumptions on growth and rate |
| P/E ratio | Share price divided by EPS | Quick read for mature firms | Distorted by sector and earnings cycle |
| P/S ratio | Market cap divided by revenue | Useful for loss-making growth firms | Ignores margins and capital structure |
| EV/EBITDA | Enterprise value over operating profit | Fair across different debt loads | Hides genuine capex needs |
Damodaran teaches both lenses. Most UK retail investors only ever use one.
Key takeaways
Discounted cash flow (DCF) valuation estimates an investment's worth by projecting future cash flows and discounting them back to the present.
UK investors can use DCF to assess stocks, ETFs, and private businesses by forecasting dividends and earnings growth.
Relative valuation compares an asset's pricing to similar assets using ratios like P/E, P/S, and EV/EBITDA.
UK investors can use relative valuation to identify undervalued or overvalued stocks within the FTSE 100 or FTSE 250.