Aswath Damodaran – Laws of Valuation: Revealing the Myths and Misconceptions - Nordic Business Forum

the two things that terrify me right now the first is that robot behind me I'm not sure what it's going to do the other is 25 minutes on the dial simply because I'm so used to spending all day talking that 25 minutes to me is about how long it takes me to get warmed up so I'm going to compress what I plan to say today right at the start so if I don't get to it you kind of leave with the message the first thing I want to talk about is what I call a corporate life cycle that every company just like human beings is born it grows it matures and like every human being it declines and just as human beings don't like to age companies don't like to get old so the first message I want to talk about is this notion of a corporate life cycle and how trying to fight it is the most dangerous thing a business can do the second message I want to deliver is the focus of a company needs to change as it moves through the lifecycle from startup to growth to maturity declining companies and more value is destroyed around the world by companies not acting their age young companies that try to act old and all companies trying to be young again and there's an entire ecosystem that feeds these companies consultants bankers essentially I call them the plastic surgeons of business essentially saying I'll give you a facelift you can be young again and companies keep buying into this notion over and over again the third message I want to talk about is very specifically connected to the topic I teach which is valuation now when I say valuation for most of you what comes to your mind is spreadsheets and models and numbers right that's what we're trained to think about valuation as in thirty two years of teaching valuation I've learnt a very important lesson and took me a while to get their valuation can never just be about the numbers a good valuation always has a story embedded in it and one of the things I want to talk about is how that balance between story and numbers changes as a company goes from being a young company to an older company and the final message I want to deliver is we often talk about great CEOs and I'm gonna argue that what makes for a great CEO is going to change as you move through the lifecycle that what makes for a great CEO at a young company is very different than what makes for a great CEO in a mature company which makes is very different from what makes for a great CEO in a declining company so got a lot on the menu so I want to get started when I teach finance I use a couple of structures to kind of bring through some of the broad lessons and finance and one of the things that I find useful is the notion of a balance sheet not an accountant balance sheet I'm not an accountant and thank God for that a financial balance let me explain how a financial balance sheet is very different from an accounting balance sheet at one level it looks very similar it has assets and liabilities but in the asset side of the balance sheet instead of breaking things down the way accounting student of fixed assets and current assets and financial assets and intangible assets I divide the assets of a business into assets in place investments it's already made as a company and growth assets so but look at a couple like Microsoft assets in place would include office and windows and what they already have in place but growth assets is the value that I'm attaching to what I expect you to do next year two years out five years or ten years out forever assets in place in growth assets and on the other side of the balance sheet they're only two ways you can find a business you can borrow the money or use your own money borrowed money we can call debt and using your own money's equity we can dance around these two words as much as we want but you have debt inequity and here's how that structure is going to help me think through the stages in the life cycle so here's my corporate life cycle which I promised you at the start so as I go through each stage in the lifecycle I throw a few examples at you and I'd like you to think about your company and where it falls in the lifecycle because in a sense for some of you this is going to be depressing when you put your company in the lifecycle but it is what it is so start at the process the birth of a company's of course a start-up and you can think about startups in different sectors right now for instance it's artificial intelligence might be the sector where you see startups last week we had quite a commotion in in in in markets because in a company called tilray go public those of you not familiar with children it's a cannabis producing company and right now that's a hard business to be it the company quadrupled in its first three days and lost 50% in the next two days but startups are young companies just coming up there's a huge mortality rate most startups don't make it if you do make it from the startup you become a young growth company young growth companies are like teenagers and you know what teenagers do right incredibly stupid things so when you see a company like Tesla or uber when people jump on them saying how come you behave so immaturely you got to behave remember that their teenage company's teenage companies don't always think through the consequences but the future is full of potential then you've got younger old companies this is when you're at the peak of your glory this is when you can go to sleep at 3 o'clock in the morning wake up at 6 and still function you're kind of peaking then you become a young girl then you become a mature growth company these are the Facebook's and the Google's of the world we get amazing earnings crash flows and you still continue to grow but you're still enjoying life then come what I call the Middle Ages middle age is something none of us want to get to but there are worse things waiting for you if you think about it you become a mature company and then comes that final face that nobody wants to be in which is you're in decline companies are born they mature they decline it's the nature of the process and if you think about where a company falls in this process you can already start thinking about not just how this company should be run and what it should be doing but how to value the company so if you think about what causes this process to Vall here's the way to think about it some businesses are easy to enter and scale up it they don't require a huge amount of infrastructure investment they don't require decades of building up you can grow quickly some businesses take much longer to build up on that determines how quickly you go from being a start-up to a mature company once you become a mature company you get to reap the benefits of having built up a business before you're going to decline so what allows companies to grow quickly are ease of scaling up how quickly you can enter businesses and how little capital you need to grow but what causes companies to decline are exactly those same factors so I'm going to start off with what I believe is happening across the world that's changing the way we should be doing not just valuation but how we run businesses I think life cycles for companies are getting compressed the way I describe this and one of my posts on my blog was I said tech companies age and dog years know what I mean by that hundred year manufacturing companies an old company a 20 year tech company is a really old company tech companies agent dog isn't that in the in the sense that they grow from nothing to something really quickly they don't stay mature for very long before they're going to decline let me give you two contrast a few weeks ago I got a call from a reporter about GE G's had a glorious history but its history is mostly behind it watching GE today said how would he describe what G's future looks like I said it looks like the Bataan Death March there's nothing hopeful that you can see her but before you grieve for its end remember it has had a hundred and twenty-five glorious years of existence ge was founded in the last part of the 19th century it grew through much of the 20th century changed the way Americans used appliances became the one of the biggest greatest conglomerates in history before it went into decline a hundred and twenty-five years in contrast take yahoo company was founded in the early 1990s very quickly went to becoming a hundred billion dollar company in the face of seven to eight years what took GE fifty years to do Yahoo did in seven years it stayed as a mature company for about seven years before it went into decline and now all you have when you look at Yahoo is a walking dead company there is nothing left at the I mean what can you and I remember about four years ago value Yahoo and I initially valued its basic business which is a search engine that nobody searches on a male program that nobody sends mail on and essentially even in its best days you can say it's worth about three to four billion the company of course was trading at about 40 billion you know why right there are two big holdings a 21 percent share of Alibaba which was what about 30 billion and a 35 percent share of Yahoo Japan for some reason the Japanese still seem to search for things on Yahoo don't ask me why but this is a company that went from being a start-up to a large company to nothing in a face of 25 years I could say the same story about Nokia a company that is said or Blackberry if you look at the great companies that start in the seventies in the eighties especially in the technology space the lifecycle for these come is essentially as compressed and I think we need to adapt the way we think about business to reflect these compressed life cycles so let me start on the first of the three things I want to talk about relate to the life cycle I teach two classes as my introduction specified I teach a corporate finance class and I teach a valuation class you asked me to describe the difference between these two classes here is the way I describe the differences in valuation I look at companies from the outside in I look at a company as an investor asking how much would I pay for this company given the way it's run that's valuation in corporate finance I look at the same companies through the inside-out essentially as a manager saying if I were running these companies how would I run them differently and people are always surprised by this because they think I write a lot about valuation so that's what I must prefer I prefer teaching the corporate finance class because I get more degrees of freedom more levers that I can move around to change the value of a company and if you ask me to summarize my value of my corporate finance class I actually do it on one page this is all the corporate finance you need to know if you've never taken a corporate finance class there are three basic principles or decisions driving businesses there's the investment decision where you decide what projects to take what assets to invest in and the principle that governs how you invest is a very simple one go out and take investments that earn more than your minimum acceptable hurdle rate that's basically the rule how you measure the hurdle rate and how you measure returns is full of details but that's the basic principle see investment principle take good projects fund them well remember I said there were two ways to run a business or fun to business one is to borrow money and the others to use equity find the mix of debt and equity that minimizes your hurdle rate it's better to have an 8% hurdle rate than a 10% hurdle rate and there's a third principle it's called the dividend principle and here's what it says if you cannot find investments that make your hurdle rate give their cash back to the owners of the business let them find a better place for it invest the investment principle the financing principle the dividend principle every business has to make investment decisions financing decisions and dividend decisions now let's think about how the focus of a business changes depending on where you are in the life cycle when you're a startup the only decision you really should be spending your time on is the investment decision here's why how much money can a young startup afford to borrow the answer is none you should not be borrowing money and here's why when you borrow money you got to make interest payments those interest payments you can't make with potential you can try you can go to the bank and say I have lots of potential can I pay with potential it doesn't work and you guys mean how much can I afford to pay in dividends what dividends you're a young startup you have no cash available to paying dividends everything you do as a start-up is built around making good investments you got to build up those growth assets as companies mature they can start thinking about the financing principle they say what come weeks of debt and equity is right for me as a company so as companies mature you're going to see the finance part of the business take a bigger role and then you get to be declining businesses your job is to give cash back to the owners the focus shifts to the dividend principal the investment principle the financing principle the dividend principle young company should be focused on investments mature companies can think about financing makes declining company should be thinking about dividends remember at the start of the session I said that one of my biggest problems with companies is companies that refuse to act their age I describe them as the equivalent of 50 year olds wearing hip huggers it is not appropriate but many companies try to act ages that are not right for them let me give you an example a young company that goes out and borrows money I don't get it why if you're a young company would you put your entire future at risk by going out and borrowing money two years ago I mean Tesla is one of these companies that I've been tracking for a while simply because it fascinates me as a company it's nice to have a CEO as you know who's constantly throwing you know Pureland on flames making it go up more but the company I've tracked for a while but two years ago Tesla went out and borrowed five billion dollars and I never understood it why would a company like Tesla that's a money-losing company it should be focused on building up the business go out and borrow money young companies that borrow money I don't get mature companies that tried to go back to being young companies I don't get it declining companies that try to reinvent themselves as mature companies I don't get and in the process they destroy value because they're trying to be something that they cannot be so the next time you see a company doing something big doing an acquisition why because we want to be young again the analogy I give is you're trying to be something you really cannot try to be Walmart what flip card flip card is Indian Indian online retail company a company that is a money-losing machine that's been burning through cash for the last 10 years with no end in sight Walmart paid 21 billion dollars I called it the most expensive facelift in history because that's what it was a 21 billion dollar expenditure why because Walmart wants to be young again and like all facelifts gravity works it's wonders and three years from now Walmart relaxing what can we do next but here's where the ecosystem kicks in and that ecosystem includes a great deal of what we hear about in management restructure yourself reinvent yourself innovate hey that's all good but if you're a consultant or a banker you want companies that want to look younger because you can tell if you do this you'll be younger again so when companies refuse to act their age their investors pay a price which brings me to the cash flow side of this equation if you're a young company remember you're building up the business you're investing a great deal you're often losing money because you're building up businesses you will tend to have negative cash flows there is a notion called cash but investors sometimes say hey that company is burning through cash by itself there's nothing wrong with the cash point if you're a young company cash burn is a feature not a bug for young companies because they have to burn through cash to build themselves up so you got to live through that cash burn but if you're a good business at some point in time that cash burn has to stop you have to start to generate positive cash flows and I'm not being just old-fashioned here that's been at the basis for business for as long as businesses have been around it's not that you need to make money right from the start but eventually you have to make money so when you look at a business one of the ways to identify where our businesses and the life cycle is look at its cash flows last week I valued Amazon and this is a company that to me is the most difficult company in the world to value and the reason is I'm not sure what business it's in anymore anymore I used to think Amazon was a retail company I've given up on that notion here that's what I think it is I in fact I used to call Amazon my Field of Dreams company have you ever seen the movie Field of Dreams remember the line in that movie that everybody walks out of the movie is still remembering if we build it they will come that was the Amazon theme song right if we build it they will come if we build what revenues they will come which they profits for 20 years amazon has been run as a company saying we will build it then they will come I used to think I Amazon was a retail company I no longer think it is I think it's a disruption platform then can effectively go after any business on the face of the earth and here's one thing we can guarantee with Amazon whatever business it goes into I don't know whether Amazon will ever make money but here's one thing I will guarantee you if you're any other company in that business I will guarantee you will now lose money so we are in any the Amazon targets no bad things are gonna happen to you do you know that the day Amazon enters any business collectively in that business everybody else loses tens ability the day they entered the grocery business collectively other grocery companies lost 40 billion dollars in market capitalization on that one day so whatever business you're in every night get down on your knees and say please God don't let Amazon come into my business because they will destroy your business and leave nothing there so then our district destruct a disruption platform with an army you know what their army is called it's called Amazon Prime a hundred and ten million absolutely loyal members that they can turn loose on any business they want so last week when I valued Amazon I was trying to put in the life cycle I'm not sure where it is right now it's not definitely not behaving like a mature company it's actually behaving like a young growth company with a trillion dollars in market cap behind it it's never been seen before in history and I'm not sure what's going to happen next but it's going to be fun watching but it's not gonna be fun playing against it so the reality checks that that companies need to think about is first for young companies you have to remember cash bird is going to happen you can't fight it for mature companies have recognized things will start to slow down you can't fight the slowing down of growth and once you start declining you have to start thinking about how do we give cash back to the owners this is big debate in the u.s. about buybacks about how buybacks are a terrible thing and you've heard the story right when companies buy back stock that cash is not being invested back in the company to which my response is what's wrong with that do you really want GM investing your money back into their business if you look at the hundred large business how largest business the US I would send sixty to seventy percent these businesses they're investing back in the business is almost a guarantee that that man going to get burnt through there's nothing wrong with company saying hey you know what there's nothing to invest in take the cash back that cash doesn't leave the market it just goes back into other businesses which brings me to my third phase which is this notion of connecting stories numbers as I said when I first started teaching valuation I used to think it was all about the numbers it's really not about the numbers to me a good valuation is a bridge between stories and numbers no I mean by bridge between stories numbers when you show me a valuation you point to a number said why is that number what it is my answer is never going to be because I used to 25% growth rate for the first five years and five percent thereafter it's always going to be a story every number in my valuation have a story behind it and every story that I tell about a company has to have a number attached to it I'm only about two minutes I'm going to compress what I say about stories and valuations with young companies it's all about the story when I valued uber in June of 2014 this was a start-up still a young company losing a lot of money my entire valuation was built around my story about uber being an urban car service company that drove my entire valuation and when I finished my evaluation one of you Burres lead investors bill Gurley venture capitalist leading investor in uber said you got the story all wrong uber is not a car service company it's a logistics company notice how words have consequences by using the word logistics what's he done he's tripled the size of his business we could be in delivery and moving he said we're not just urban we're going to be everywhere and he said we're not just gonna have local networking benefits were gonna have global networking benefits in fact when he told that story I valued the story for him my value for uber was six billion his value was fifty three billion what separated us was the story we told with young companies your story will define evaluation so if you're a founder the words you used to describe your business can mean the difference between a six billion dollar valuation and a fifty three billion dollar value with mature companies it's the numbers that drive your valuation because you it's like being in chapter 34 over 35 chapter book I can't reinvent the characters so if I'm valuing coca-cola I can't make you a young tech company and give you all these neat things the older a company gets some more than numbers drive the valuation which brings me to my final theme because only 24 seconds you know the right CEO for a company's pure young startup who do you want is you CEO it's all about story you want Steve the visionary gave the name Steve for obvious reasons you want the storyteller as you become a young growth company you want Bob the Builder right because you got to start building a business as you become a mature company you need dawn the defender then you become a declining company you need to you know you know who you need as you cou need Larry the liquidator if you've never seen the movie other people's money I'd strongly recommend it Danny DeVito plays the role of Larry the liquidator the right CEO of our companies different in different stages and years where that compressed life cycle kicks in if you look at a complex you 125 years to get from young to really old your CEO is passed on mortality kicked in but if you're a CEO of a young tech company you could very well find yourself running a mature or a declining tech company and the same CEO might no longer be the right CEO for you I'll make a prediction you're going to see a lot more disruption in management ranks because life cycles have become compressed you're already seeing this play out with Tesla right was Iran must the right CEO to build up absolutely the guy has visions coming out of his nose his eyes is every conceivable orifice but is either right CEO to build an automobile company I'm not so sure and this is something we're going to face and a lot of companies great founders suddenly being inappropriate CEOs for the kinds of companies these companies abut so get used to a lot more excitement in the ranks if you're watching from the outside but if you're CEO one of these companies get used a lot more excitement from the inside and it's not going to be as much fun so that's pretty much what I wanted to say so I wanted to open up to any questions so I'm going to let I think that's going to the questions are going to come out I'm pretty sure they are I am [Music] thank you that was fascinating I wouldn't say our cup runneth over with time right now so let me ask you just to give us a straight you've been hinting around at it but somebody somebody in fact it was Dominique sent in a question yeah and it's about Elon Musk and is he right see now you're hinting around I just want a yes or no for these people who deserve the truth they could handle the truth okay I'm gonna give you a long-winded answer because I mean but I want it remember say when we talk about Steve Jobs we remember Steve Jobs the great CEO I've been an Apple investor since 1981 I remember Steve Jobs who almost destroyed Apple as a company he built the Lisa I bought the Lisa horrible computer so the first iteration of Steve Jobs he was not the right CEO of rapid right second iteration somehow I became this magical success story you know what was different he had a chief operating officer named Tim Cook who doesn't have a visionary born in his body but he can make the trains run on time that was the difference so my answer for Elon Musk is Tesla needs Elon Musk but he needs a chief operating officer who is willing to trust and give power to and not tweet about every 15 seconds on and if he does that I think he can pull it off so it's doable I don't know what he has there he's willing to put his ego to the side but that's I think the answer to that question ladies and gentlemen ah dah dah dah dah oh thank you thank you

Channel: Nordic Business Forum

Views: 452,155

Rating: 4.9345078 out of 5

Keywords: nbf, nordic, business, forum, nordic business forum, Aswath Damodaran, valuation, stock market, business news, aswath damodaran valuation, aswath damodaran nordic business forum, aswath damodaran laws of valuation, aswath damodaran lectures

Id: c20_S-QgvsA

Length: 28min 48sec (1728 seconds)

Published: Mon Nov 12 2018

Reddit Comments

[u/scaredycat_z]

So lots of comments here putting down Prof. Damodaran.

Not going to defend him. The comments are honest and not wrong. In fact, I agree with basically each one, but some points that I would like to remind people of:

1) He is very honest with his assumptions.

2) He makes his data (and tons of other stuff) freely available to all. I truly think he really just wants to teach. Why hate on him?

3) He's definitely made bad calls. But let's be honest, as a teacher, he needs to discuss and use real practical examples that engage the students, something they will enjoy and understand. Therefore, most of his valuations and articles are about well-known companies, including young growth companies, which can take years to see if you are right or wrong; during which the valuation can change drastically due to totally unforeseen events or technologies. That's what's in the headlines, so that what he uses.

Imagine if he found a nano-cap stock and used that as his example for valuation. Chances are most students would not be interested since they've never heard of that company. Instead, he needs to use well-known, large-cap stocks. An even greater chance that his students would prefer to hear about Amazon or Tesla (growth stories) then about GM, GE, or some other older companies. He needs to capture their interests and keep them engaged.

So yes. He's made some bad calls. And yes, he's probably not doing much better than any given index. But is that his goal?

[u/Open_Thinker]

Here's a lecture Dr. Damodaran gave in Helsinki a couple months ago that I don't think has been posted here before. Actually I don't think it's one of his better lectures, but some here may be interested in giving a watch.

[u/r_silver1]

I have listened to a few of his talks, and own his little book of valuation. Have not went through his investment valuation textbook, because honestly the little book was way to theoretical to have any practical use. Maybe its not fair to judge him off of the readers digest version of what he teaches.

I think most valuation falls short because the formulae can be correct, but any input that requires forecasting is going to give an innacurate output. DCF comes to mind.

[u/indigoreality]

I would really love to attend a live lecture from him. Anyone know if it's open to all?

[u/Financeoholic]

At 15:00, he asks "why do young companies borrow money?"

My retort is how else do young companies acquire capital to grow and expand? I know Damodaran is a valuation guru and he probably has a great answer to this question. But with a low cost of debt and trying to expand operations, it makes sense to borrow does it not? Especially since young companies probably don't have loads of free cash flow coming in yet.