Valuation: Measuring and Managing the Value of Companies

by McKinsey & Company Inc, Tim Koller, Marc Goedhart

McKinsey & Company's #1 best-selling guide to corporate valuation - the fully updated seventh edition Valuation, University Edition is filled with the expert guidance from McKinsey & Company that students and professors have come to rely on over nearly three decades. Now in its seventh edition, this acclaimed volume continues to help financial professionals around the world gain a deep understanding of valuation and help their companies create, manage, and maximize economic value for their shareholders. This latest edition has been carefully revised and updated throughout and includes new insights on topics such as digital, ESG (environmental, social, and governance), and long-term investing, as well as fresh case studies.

Genres: Finance, Business, Economics, Nonfiction, Management, Accounting, Money

960 pages, Paperback

First published January 1, 1990

Reviews

[InvestingByTheBooks.com · Rating 5 out of 5]

On a basic level there are two competing mental models of stock values in the financial sector. The first is that the value of something is what someone is prepared to pay for that something. In the equity market this leads to statements such as “the valuation of a stock is low” if the current market pricing of the stock is historically low compared to, for example, the estimate of the near term future earnings. The other model is based on that a company has a fundamental intrinsic value that is separate from the market pricing of its equity. This book is about both how to estimate this intrinsic value and also on how to create it.

Out of all the books reviewed on this website Valuation is probably the one that sits on most shelves behind workstations of employees in the financial sector. The reason is that most of us have had it as a text book at university, but compared to all the other text books this one is also a handbook in corporate valuation that is used by practitioners. For those who use the concept of intrinsic value, cash flow valuation has become the standard methodology and Valuation is the standard source material. The book is mandatory reading for persons within corporate finance, venture capital and private equity who are slightly less close to the public stock market. It is less widely used by portfolio managers or sell side analysts who often look to shorter time horizons.

There are obviously competing text books on valuation such as Damodaran on Valuation. Where professor Aswath Damodaran’s writing is academic and covers more ground with regards to different aspects of securities valuation, Valuation is a practical book that connects valuation to corporate strategy and value based management. Two of the he authors of Valuation are employed by McKinsey and the main focus is on one specific method of valuation. This is a fifth edition. Over the years this book has become more and more of a practitioner’s manual with consistent form, new sections on special situations and sector issues plus solutions to all kinds of practical problems in a DFC-valuation. More academic issues such as if CAPM is really a good model to use for estimating the WACC, when it has become more and more obvious that beta doesn’t work, is toned down as this would only subtract from the practical value of the book. Damodaran on Valuation is written by an academic, Valuation is written by consultants for daily use by CEOs and finance professionals.

The intrinsic value in a DCF is based on cash flows, the growth in cash flows and the risk that these future cash flows will not materialize. The cash flow in question differs; it might be dividends for stocks, coupons for bonds or after tax cash flows for businesses. The problem is that as the future is unknown the intrinsic value is unobservable. Any calculation of it is an act of faith. One strength of the DCF is that it is transparent. It requires a large number of assumptions of future performance. Each such input has a range of reasonable values and the choice of inputs can be examined and criticized. Paradoxically the construction also opens up for psychological biases. If each and one of the many inputs are tweaked in a slightly more optimistic or pessimistic direction the multiplier effect of all those small (but one by one reasonable) changes will bring huge swings in the calculated intrinsic value. The fact that a DCF could be made to show almost anything has created a mini revival for excess return valuations such as the Residual Income Model. These are close cousins to the DCF methodology, but use a) the capital base of the company and b) its ability to earn a return on capital that is higher than the cost of capital as the two main inputs. Using the capital as the base for the valuation makes it potentially less dependent on estimates of an unknowable future.

This book is unbeatable for the practitioner who needs the tools for valuing a company or must understand how other do just that. More philosophical issues are to be sought elsewhere.

[Minh Anh · Rating 5 out of 5]

(5th edition)

When you start your career in Finance / Investment industry, especially financial analyst, it must be your bible. From experiences in different industries for many years working as a strategic consulting firm, McKinsey's experts have given us tons of research & insight those would never be revealed and summarized in any other documents. Nearly 900 pages of this book will take us a large amount of time to read, to comprehend, to understand what the authors want to deliver. It's not only a thorough perspective about Discounted Cash Flows (DCF) model but the best way to approach to any company valuation.

There are also 3 key points I supposed that we can conclude after all:
1. DCF model is still the best way to value a company regardless its industry but we need to use it correctly & creatively. Only some minor techniques in process are distinctive. Probability analysis also contribute a large portion in execute DCF model smoothly with normally 2 scenario (base-case & extreme-one). Part Six also gives us hints when using DCF model to value some special cases as high-growth companies or banks.
2. The difference between Return on Invested Capital (ROIC) & Weighted Average Cost of Capital (WACC) is the most crucial performance tracker of every single enterprise. While ROIC maybe calculated without obstacles (for companies with reliable financial numbers), WACC is the true pain because of appearances of too many variables such as risk-free rate (with emerging market), beta (levered or unlevered), expected market returns and some other risk premiums.
3. Always research collectively & exhaustively about the industry that company we valuing operates in. Must try to figure out the key value drivers in the industry because they are the most reliable sources for us to use as a basis for assumptions when forecasting company's financial position.

[Dzabinski · Rating 3 out of 5]

I studied this book with the hopes of gaining some more in depth methodology for valuation. This has a lot of information but is admittedly a little beyond my ability at the time. I think the information is solid and it will be something I keep on hand as a reference text especially as I get a little more established.

With that being said, I'm not completely sold on the accuracy of Discounted Free Cash Flow with the methods being purported. I feel like it leaves too much up to speculation and especially with how complicated it gets to calculate I expect I would never feel the sense of precision I would like after working through it.

I'll possibly update a review upon revisiting this book but I am currently of a neutral opinion towards it.

[Tariq · Rating 5 out of 5]

An amazing valuation book

This book added a lot of insights to me! I would recommend it for college students, professionals, and corporate executives.

[Renata Sandor · Rating 4 out of 5]

I needed to go through this book very fast, but overall it is a good book with a lot of examples from life. I read the 6th and 7th edition parallel as the school updated the literature in the last minute. I think if you buy a new one, it's worth to invest in the newest edition. It has a lot of updates, especially market related ones. You can get a better grasp of how the market looks right now.

This book helped me form a better portfolio. The very first chapters put you in deep water: overwhelming amount of formulas. As you manage to read the first 6 chapters things become more clear. Be patient.

One thing this book won't show you is how to calculate EBIT, NOPLAT and other stuffs in your DCF model in practice. The formulas the book suggest are not the same we used to build the model. You need to connect the dots by yourself and it's quite a work.

[Asif · Rating 5 out of 5]

One of the best books I ever read

[Sai Suman Mirthipati · Rating 5 out of 5]

Masterclass in valuation

[Salvatore Lizio · Rating 5 out of 5]

The best book ever

[Peter · Rating 4 out of 5]

(7th edition)

Great reference on valuation of companies and covers the topics very well from a theoretical perspective. Nice case examples. Not exactly "readable", but a great course book and one I'll keep in my bookshelf for later.

[Sergio Medinaceli · Rating 4 out of 5]

Lo mejor de este libro son los ejemplos ficticios y sencillos que tiene. Lo recomiendo.

[Farhad · Rating 5 out of 5]

This is the best book I’ve come across on the topic. It breaks down the fundamentals of how value is created and various approaches for measuring it. It doesn’t matter whether you are a subscriber to the efficient market hypothesis or if you think stock price volatility is a silly way to measure risk. It goes beyond cookie-cutter descriptions and is a must read for anyone interested in understanding what drives the value of companies, whether for personal or professional purposes. This book is not meant to shape your philosophy to valuation but contains core principles that must be learned before you are allowed to even have an opinion.

[Dunkelheit · Rating 5 out of 5]

The first part is very insightful to learn what makes great companies great and how they sustain their competitive advantages based on 2 concepts: ROIC and growth. I got lost in the 2nd and 3rd part about valuation techniques and skipped most of it. The 4th part is interesting to read, mainly for managers and people who want to know better what decisions and models are useful to invest in. Finally, the last part goes deeper in special situations (emerging markets, high-growth, M&A...) and a shallow reading is quite informative if you (like me) don't want to mess with the numbers.

I give it 5 stars because I will likely come back to it again and again during my life as investor.

[Andrew · Rating 4 out of 5]

This book does a good job explaining basic valuation (doesn't go super in depth on all valuation concepts). But, what I really enjoy about the book, and where the value is, is that is describes the concept of value creation and destruction. With that, it provides ways to think about it, ways to analyze it, and formulas to apply it in valuation.

[Piotr · Rating 3 out of 5]

The book is extremely technical and full of practical tools - might be boring for some practitioners. Nevertheless there's also a lot of practical and interesting thoughts about value creation in an enterprise, esp. by actively managing corporate lines portfolio.

[Ben · Rating 4 out of 5]

About as accessible and readable as a textbook about valuation could be. Lots of critical information, clearly presented. Also lots of arcane accounting stuff I skipped, but I bet those parts are also good if they’re relevant for you.

[Mahuang59 · Rating 4 out of 5]

A very good reference book on identifying underlying value.

[Harry Harman]

companies that grow and earn a return oncapital that exceeds their cost of capital create value.

Investors in most companies don’t know what’s really goingoninsideacompanyorwhatdecisionsmanagersaremaking.Theycan’t know, for example, whether the company is improving its margins by finding more efficient ways to work or by simply skimping on product development, maintenance, or marketing.

Lynn Stout’s book The Shareholder Value Myth argues persuasively that nothing in U.S. corporate law requires companies to focus on shareholder value creation.6 But her argument that putting shareholders first harms nearly everyone is really an argument against short-termism, not a prescription for how to make trade-offs. John Mackey, founder and co-CEO of Whole Foods Market, recently co-wrote Conscious Capitalism,8 in which he too asserts there are no trade-offs to be made.

Consider employee stakeholders. Acompany that tries to boost profits by providing a shabby work environment, underpaying employees, or skimping on benefits will have trouble attracting and retaining high-quality employees. Lower-quality employees can mean lower-quality products, reduced demand, anddamagetothebrandreputation. Moreinjury andillness can invite regulatory scrutiny and more union pressure. More turnover will inevitably increase training costs.

If the company earns more than its cost of capital, it might afford to pay above-market wages

Companies create value for their owners by investing cash now to generate more cash in the future.

adjusted to reflect the fact that tomorrow’s cash flows are worth less than today’s because of the time value of moneyandtheriskiness of future cash flows. As we will demonstrate, a company’s return on invested capital (ROIC)1 and its revenue growth together determine how revenues are converted to cash flows (and earnings).

the amount of value a company creates is governed ultimately by its ROIC, revenue growth, and ability to sustain both over time.

EXHIBIT 2.2Tale of Two Companies: Same Earnings, Different Cash Flows

To measure how a company and its management perform, analysts and investors frequentlyusetotalreturnstoshareholders(TRS).Thismeasurecombines the amount shareholders gain through any increase in the share price over a given period with the sum of dividends paid to them over the period.1 That sounds like a good idea: if managers focus on improving TRS to win performance bonuses, then their interests and the interests of their shareholders should be aligned. Managers running full tilt on the expectations treadmill may be tempted to pursue ideas that give an immediate bump to their TRS.

[Mike · Rating 4 out of 5]

Books either fulfill their purpose or they don't. If you understand the basics of finance (300 level-ready and above) and you want one book to read and then use as a reference to learn how to understand and conduct business valuations, this is one of the books to consider. It will be over some readers' heads, but its focus is broad and covers some basics, so there's likely something else that better suits the needs of an expert looking for a deeper understanding of one specific issue. But it covers valuation principles well and delves into the common complicating factors, the most commonly relevant theoretical challenges, etc.

[Arjun Pathy · Rating 4 out of 5]

Chapters 10, 16, 17, 33 - in true McKinsey fashion, this book was highly technical and dense. However, corporate finance in its raw form is naturally a bit painful to read at times. I appreciate how this book bridged the concepts of good organizational management and good financial management. Furthermore, by contextualizing concepts with examples, I gained a broader idea of the interconnection between all the valuation methods, multiples, and metrics that exist to measure a company. Every niche financial term has some level of relevance.

[Sean Leeming · Rating 4 out of 5]

I read this when I started a new job trying to pivot to finance. Although I had an accounting background, I didn’t know anything about how markets worked. This is a great intro to basic finance concepts and how they apply to the markets. I’m not going to claim to be Warren Buffet, but this gave me a much better understanding of the financial world.

It is a textbook, so it’s not gonna give the same enjoyable narrative experience as like reading fiction. But as a textbook, it works great in explaining the basics

[Rohit Kadam · Rating 5 out of 5]

Probably the best book of equity valuation there is. More relatable to those who have already spent some time in the industry tracking and valuing companies. What makes this unique is the very practical and hands on advice which can be straightaway applied on the job. At the same time this is also a conceptually sound book.

[V Narayanan · Rating 4 out of 5]

1. I learned how to run the valuation practice more than how to do valuation from this book

2. Book is well nuances but could have been written in a better language and style -- language flow changes frequently - from conversational to academic write up, simplification and complications are felt simultaneously.

[Daniel Palevski · Rating 4 out of 5]

A classic on the subject of the financial valuation of companies and business lines. It also includes a great chapter on unearthing hidden value within a corporation via restructuring and the manipulation of value levers.

[Mikhail · Rating 4 out of 5]

Good overview of valuation, but somewhat limited discussion on management of value

[JuanK Russo · Rating 5 out of 5]

A classic textbook for all appraisers. Obligated lecture.

[Sudhir Kulaye · Rating 5 out of 5]

A must-read book for every Value Investor / Equity Research Professionals. I would also like to read the latest (7th) edition for the ESG aspect in valuation.

[MonkeyFreeTime · Rating 5 out of 5]

One of the best books in Valuation, no doubt about it.

[Michael Herlache MBA · Rating 5 out of 5]

Amazing book on valuation and why we value value.

[Herr · Rating 4 out of 5]

One key takeaway. Return on Invested Capital. ROIC.

[Daniel ORourke · Rating 4 out of 5]

Good for both overview and in-depth. The reader can skip in-depth math chapters if unneeded