Prof Aswath Damodaran on Valuation

Written by

Jae Jun

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What You’ll Learn

• The most egregious mistakes made by investment professionals
• Basic principles of the professors valuation and why pricing is different than valuation
• About founder-centric companies and copanies with great management

Another great interview with Prof. Aswath Damodaran. This man is so full of knowledge and unconventional wisdom.

You can read the full article here.

In this interview Prof. Damodaran answer questions about valuation, corporate finance, and advice to investment professionals.

Notes and point form below.

The Biggest Mistake by Investment Professionals

• Investors mistake price for value.
• Relative valuation is frequently used and this is pricing a number to a stock. Not real valuation. Basing off what other people are paying for similar stocks.
• Valuation is about digging through a business, understanding:
  • it’s cash flow
  • growth
  • risk
  • then trying to attach a number to a business based on value as a business
• Nothing wrong with pricing. It’s just not valuation.

Valuing Companies where Stock is Based on Narrative and Hype

• Pricing process is based on mood and momentum – does not affect value of a company
• What to do if real valuation is very different to the price? Markets can stay wrong longer than you can stay solvent. Price may continue on up, even though your valuation is correct.

On Valuing Tesla

• Story of Tesla is like nailing jello to a wall.
• Tesla not a company but more a reflection of Elon Musk
• Not sure what kind of company Tesla is. It’s still an automobile business.
• Musk has many things going on, and you are not getting 100% of Musk. He is committed to SpaceX, Tesla, Boring Company. With Tesla, you are only getting a piece of him.
• Better to have a company with a strong management team.
• Difference between Tesla and Amazon is that Bezos is not tweeting and putting himself in the headlines.
• Bezos knows that he has to build a good management team in order to be successful.
• It’s okay to have a founder driven company as long as you build a strong management
• Like Berkshire, it’s not all about Buffett. Munger is the counterweight and then there’s also Jain.

Amazon as a Pet Obsession

• Because Amazon stays with its story through good times and bad times.
• Patience is built in its DNA.
• How to build a story stock:
  1. Have a story
  2. tell the same story
  3. Act consistently on that story
  4. Deliver on that story

Example Where Valuation Didn’t Work

• Found a Brazilian iron mining company – found it undervalued, bought stock.
• 2013 iron ore prices were falling. Assumed that it was going to recover.
• The lesson from the valuation, was that for iron ore mining companies, it takes about 2 or 3 years for shifting iron ore prices to shorten earnings.
• Bought at the wrong time, lost some money. Learned that valuing commodity companies isn’t just taking monthly numbers and projecting. Have to look over different periods.

The Biggest Valuation Mistakes VCs Make When Investing in Tech Companies with Userbase

• Biggest mistake is that VCs don’t value users, they price them.
• VC’s assume all users and data have value.
• Some are useful, some are useless. e.g. Moviepass users are many but useless. Netflix users are useful.
• Question how to differentiate between value adding and no value users.

Innovation in Valuation Methodology During Career

• Almost no innovation.
• Valuation is not about methodology. It’s about adapting your techniques to real world challenges.
• We have to think globally.
• Be careful about risk premiums, currencies, and how we use them in valuations.
• As company life cycles shorten (eg Yahoo) our valuation should adapt to those.

How to Approach Goodwill in Valuation

• More work for accountants.
• Fair value accounting has given accounting a new business (the biggest growth business in accounting).
• It’s useless – from an investor perspective.
• “I think accounting balance sheets are the least useful financial statements. I’d much rather take a statement of cash flows over one of these fair value balance sheets.”
• For goodwill impairments – the impact of them is almost zero. Because it happens two years after the rest of us know it’s happened. Nobody cares.

Books or Investors That Impacted Investment and Valuation Philosophy

• Spend less time on introspection and reading what other people think and do in investing.
• Must understand yourself best to be a good investor – not others.
• Not enough to understand what Warren Buffett and Peter Lynch does.
• I spend very little time reading investment books.
• Own your investment philosophies.
• Read the news of today and try to figure out why companies are doing what they’re doing, rather than focusing on what other people think about companies. Or what other people think about investing.

Biggest Price to Value Dislocation

• The biggest divergence is in young tech companies. That’s always been true.
• Sector valuation is a dangerous game because you’re investing in a portfolio of companies.
• Getting angry, frustrated and become righteous about investing will get into trouble.

Crypto Currencies

• You cannot value a currency – you can only price it. You price it on how good it is as a currency.
• BTC is a terrible currency.
• Can’t live your life with BTC in your pocket
• To make BTC a currency, people should work on making it a currency instead of a speculative investment.

US Market Valuation

• Looking at the equity risk premium, price can be justified.
• The big question is whether buybacks is trapped cash being returned, or whether it’s going to subside.
• Good as long as there’s growth backing the buybacks.
• Keep eyes on economic growth.
• Start worrying if there is staggering and weakness in economic growth.
• I’m not looking at the market, or CAPE or P/E, or other traditional measures, I’m looking at economic growth.
• As long as economic growth is solid, I’m okay with the market.

Full interview at Sumzero.