What Valuation Is Actually For

Valuation is often presented as a way to arrive at a correct price. Build the model, choose the right inputs, and the answer should emerge.

In practice, valuation rarely works that way.

Different investors can value the same business using the same information and arrive at very different conclusions. The disagreement is not usually mathematical. It is rooted in assumptions, judgment, and what each investor is trying to solve for.

Understanding what valuation is for matters more than mastering any single method.

Valuation Is a Language

At its core, valuation is a way of translating beliefs about the future into numbers.

Growth assumptions, margins, reinvestment, and discount rates are not facts. They are expressions of how an investor sees the business evolving over time. The model simply forces those views to be stated explicitly.

This is why valuation is useful even when it is wrong. It reveals what must be true for a price to make sense.

A reverse DCF does this directly. Starting from the current price and working backward exposes the expectations embedded in it. Whether those expectations are reasonable is a separate question, but they can no longer remain vague.

Precision Is Not the Objective

Financial models often produce outputs with two decimal places. This can give the impression of accuracy.

That impression is misleading.

The further into the future cash flows are projected, the wider the range of possible outcomes becomes. Small changes in assumptions can produce large changes in value. This is not a flaw in modelling. It reflects the reality of uncertainty.

Trying to compensate for uncertainty by adding complexity rarely helps. It obscures the key drivers and creates a false sense of control.

Valuation is not about finding the right number. It is about understanding the range of plausible outcomes and where the current price sits within that range.

Discount Rates and Uncertainty

One area where philosophy shows up clearly is the choice of discount rate.

Many investors attempt to account for risk by increasing the discount rate. A higher required return is meant to compensate for uncertainty. The risk is absorbed into the rate.

Others take a different approach. Buffett has often described using the risk-free rate as a starting point, then demanding a margin of safety in the cash flows themselves. The uncertainty is confronted directly rather than hidden inside a higher discount rate.

The distinction is subtle but important.

Raising the discount rate can make a valuation look conservative without clarifying what could go wrong. Demanding a margin of safety forces the investor to think explicitly about durability, downside scenarios, and what needs to happen for capital to be preserved.

Both approaches can be defensible. What matters is being clear about which problem valuation is solving.

Valuation Does Not Create Opportunity

Valuation does not, by itself, make an investment attractive.

A stock can appear cheap for long periods if nothing changes. A business can trade at a fair price and still produce strong returns if expectations are too low. Price responds to shifts in belief and constraint, not to spreadsheets.

This is why valuation should be seen as a filter rather than a trigger. It helps rule out ideas that rely on unrealistic assumptions. It clarifies where expectations are already demanding. It does not tell you when price will move.

Confusing valuation with timing leads to frustration.

The Role of Margin of Safety

Because valuation is imprecise, the margin of safety matters.

A margin of safety is not a single percentage or rule. It reflects how confident the investor is in the underlying assumptions and how resilient the business appears to be.

The less certain the future, the wider the margin needs to be. This is not captured by a formula. It is a judgment call informed by experience, simplicity, and an understanding of where things tend to break.

Valuation provides the framework. Judgment supplies the discipline.

What Valuation Is Not

Valuation is not a prediction. It does not forecast short-term price movements. It does not protect against all losses.

It is a tool for thinking clearly about what is already in the price and what must happen for an investment to work.

Used properly, it sharpens understanding. Used mechanically, it creates confidence without insight.

Why This Matters

Investors who treat valuation as a source of truth often overestimate its power. Those who dismiss it entirely give up a valuable way of organising thought.

Valuation sits between narrative and reality. It forces stories to confront arithmetic and forces numbers to confront uncertainty.

Knowing what valuation is for helps keep it in its proper place. As a translator, not a verdict. As a guide, not a guarantee.