Valuation – Measuring and Managing The Value of Companies

Valuation by McKinsey & Company is a practical guide for investment professionals, offering core principles and step-by-step methods for measuring the value of companies. The book addresses contemporary challenges such as the rise of intangible assets, network effects in technology companies, and the incorporation of ESG factors in valuation. It emphasizes that companies create value by growing and earning returns that exceed their cost of capital. The authors argue that investors often focus on the wrong metrics, such as earnings per share, and instead should concentrate on expected cash flows discounted at the cost of capital. The book provides detailed methods for calculating value using enterprise discounted cash flow (DCF) and discounted economic profit approaches, highlighting the importance of key drivers like return on invested capital, revenue growth, and free cash flow. It also offers insights into sustaining above-average growth and the role of competitive advantages in achieving premium prices and cost advantages. The book is particularly useful for asset allocators and analysts valuing rapidly growing internet and technology stocks, providing a framework for understanding the life cycle of companies and the rationale behind mergers, acquisitions, and divestitures.

Quick quotes

The guiding principle is simple: “Companies that grow and earn a return on capital that exceeds their cost of capital create value.

The authors assert that “a good analyst will focus on the key drivers of value: return on invested capital, revenue growth, and free cash flow.

The authors state, “In industries with network effects, competition is kept at bay by the low and decreasing unit costs of the market leader.