For All It’s Worth

Lori Santikian fulfills multiple roles at UCLA Anderson. She serves as faculty director of the Laurence and Lori Fink Center for Finance, where she leads a team that fosters collaborations between students, researchers and the practitioner community. As an adjunct associate professor of finance and strategy, Santikian teaches a number of courses, including an elective on corporate valuation.

“Valuation, in reality, is part science and part art,” Santikian says. “You have to get comfortable taking a stand on something that is inherently uncertain and persuade stakeholders of your view by communicating your analysis convincingly.”

Before we jump into the course, let’s start with something really basic. What’s the difference between valuation and price?

Valuation is what something is worth, the fundamental value of the asset. Price is driven more by prevailing market conditions; it’s what the market forces a buyer to pay in order to complete a transaction.

Think about it in terms of houses. In a hot market, you have to pay more for the same house. You may not agree that the house is actually worth the higher price. But if you want to make a purchase, you’re bound by what prices are at that time.

What are the main goals of the course, and what are the prerequisites?

The class is called Corporate Valuation, and the main goal is to give students confidence in valuing any kind of asset. It could be something as large as an entire firm or an individual project choice that a manager is facing within a firm, and everything in between.

This is an elective course. The expectation is that the students know the fundamentals of finance from the core curriculum and have taken or are enrolled in the corporate finance elective.

Valuation needs to be grounded in theory and justification. We spend of lot of time making sure that the students understand the underlying concepts, but it’s really a skill that you develop with practice.

The methodologies, like discounted cash flow valuation and relative valuation, aren’t rocket science. Where the skill comes in is how you apply the tools because there’s a lot of uncertainty. Everything in valuation is forward-looking and nobody has a crystal ball. You’re standing in the present and forecasting the cash profits an asset will generate in the future. The only way to make a forecast like this is to make appropriate assumptions. The other wrinkle is that the profits you forecast are not guaranteed, and they will arrive with some delay. So we also have to do some translation to convert uncertain future profits into something we can compare with known investment costs today.

Sometimes, incredibly smart, thoughtful, prepared individuals can come to opposite conclusions. That’s the nature of valuation — there is no universal truth. Your valuation reflects your view, and views can vary.

You’re making a forecast with certainty while at the same time, there are no right answers?

Well, first, there is no forecast with certainty when it comes to valuing firms or projects. That’s why I encourage students to think about valuation in ranges rather than as a specific number. You can develop confidence by thinking carefully through potential scenarios and their accompanying assumptions, but you are never certain. And I think that’s where it can be a little uncomfortable at first for students. You don’t have known inputs that you’re applying to a known equation to get a correct answer. What a student needs to practice is making assumptions and developing conviction in those assumptions. It’s about developing your own stand on the future prospects of a firm or a project.  That’s going to be based in large part on your assessment of the firm’s strategy, like the forces at play in the industry, how the firm is positioned relative to peers, whether the firm has a competitive advantage and how defensible any advantage is. These are concepts our students also learn in other courses at Anderson, so valuation is a nice opportunity to bring it all together.

What types of source material do you use for the course?

There are textbooks we use as a reference. But mostly we learn by practicing in a variety of settings, particularly through case assignments and current events.

Another important part of the class is the practitioner guest speakers. I like to give the students exposure to how valuation is implemented in practice across different asset classes. On the equity side, I bring in practitioners from both investment management and investment banking, which is a strong interest for a lot of students. On the other side of the capital structure, we look at how valuation is used in credit. To keep it fresh, I invite speakers who are active and can talk about what is going on in the markets right now.

One thing that is often overlooked when we do valuation is how other disciplines, like strategy, inform our assumptions in the valuation model inputs. I incorprorate a lot of strategy to help us think about how to forecast future profits. Really, every part of the core curriculum and many of the electives inform the assumptions because every aspect of the firm — its strategy, operations, marketing, culture, etc. — all those things drive its ability to make profits in the future.

What about the assignments and projects?

The class culminates in the final project, which is very similar to a stock pitch. The students form groups and develop a comprehensive valuation of a public company’s share price. We pick a public company so that there’s enough information to work with, but the same tools apply to a private company.

Prior to that, we have several case assignments that are self-contained and give students an opportunity to practice specific skills related to different aspects of valuation.

What types of jobs might students be prepared for once they’ve taken Corporate Valuation?

It most directly prepares students for positions in investment banking, corporate finance and some of the roles in investment management. Students who are interested in these roles very specifically need these skills.

For an entrepreneur or for someone going into a marketing role, it reduces blind spots, and it makes you better able to communicate with other stakeholders in the firm, both internal and external. It teaches you discipline around evaluating choices and allocating resources effectively.

You mentioned that two smart people with the same information sometimes reach entirely different conclusions when it comes to valuing an asset. How does that get resolved?

The negotiating element is very much a component of what drives a deal and if the disparity in the assessed value is very wide, that could just lead to a deal not going through. If you’re a buyer, and what the seller is asking is far beyond what you think an asset is worth, you just walk away, right? Similarly, if you’re a seller and the buyer isn’t offering you what you think it’s worth, you’re not going to sell.

That’s one of the reasons I say valuation is part art, part science. You’re not going to just email someone your Excel model and let it speak for itself. You actually have to persuade. So I also emphasize that it’s both numbers and narrative. With the final project, students turn in a written report and make an oral a presentation in class. The reason we have both is that it’s just as important to practice how to communicate your assumptions and the story behind your model.

It’s important to take someone on the journey with you and convince them in the end. It doesn’t matter how good or correct your model is if it’s not going to influence anyone. So, whether you’re a manager advocating for more resources and capital to invest in a new product or making some other kind of investment choice, you have to persuade. Same thing if you’re trying to get capital from investors. If you’re an entrepreneur, you have to persuade with your pitch. How you communicate outside your numbers is a really important skill and the final project is designed to give students some practice.