Sunday Brunch: what is this investment worth?

Sunday Brunch: what is this investment worth?

How we create narratives to generate financial forecasts impacts the valuation process

...and the investor is 'betting' that market expectations about that investment are wrong, and that this incorrect narrative means that the share price will move" - Rappaport & Mauboussin

What a project or investment is worth is a key driver in the willingness of investors to put money into it. This applies even to impact investments, we still need to know what financial return we will earn, even if that is not our primary motivation for the investment. And yet, how investors actually value investment opportunities is really poorly understood. In fact, I would go further and argue this misunderstanding creates the biggest gap between sustainability professionals and finance people. And failing to bridge this gap stops some really positive and sustainable projects getting built.

The good news is that by learning some important financial concepts, sustainability professionals can get a lot better at communicating with finance people, and persuading them to invest.

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The process of valuation doesn't work the way you think.

When finance people try to teach sustainability professionals how to value an investment opportunity, they normally get straight into the mathematical detail. Lot's of accounting (profit and loss, cashflow and balance sheets) and some very detailed forecasting of capex, profit margins, and depreciation. And by doing so they miss the most important step, the one that means the whole process make sense. And the one that you need hardly any financial knowledge to master.

That step is the narrative. What business is this company in, how will the industry change over the coming years/decades, why will customers buy their product or service, what competition will they face, and why will customers pay more for the product or service than it costs to make it?

Regular readers will know that I am a bit of a fan of the work of Aswath Damodaran at NY Stern. Now, to be clear, I don't agree with everything he writes, but his work on Narrative & Numbers is incredibly useful, especially to non finance people. If you want to make your arguments to financial people more powerful and convincing, it's well worth a read.

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