How To Value Businesses During COVID? | Aswath Damodaran To ET NOW

is one such guest which all of us always look up to to understand the complex matrix of how to really decode valuations in this complex environment where the new new normal really cannot be defined professor welcome to eti now thank you for joining us hope all is well and everything is fine at your end thank you i'm glad to be back professor the world can clearly be divided in two parts the optimists who believe that a vaccine would be found liquidity will ensure asset prices remain strong and we could be in for a surprise v-shape recovery as the consumer demand unleashes in the first half of next year then there are some realist who would again insist that medical breakthrough is still a distance away the collateral damage to the economy is very large and since world has never experienced a lockdown ever even during world war there is no template which will tell you what is coming next i think they're both wrong in a sense i think you can't look at this bowl as fully full or empty it's it's always going to be hard for one of the reasons i'm not a market danger is on issues like this it's sometimes better to let the market decide because we think of the market as this monolithic device but it's really a consensus of what both optimists and pessimists right now in the us the optimistic side is winning that battle doesn't mean it's it's over right two weeks from now four weeks from now six weeks now from now it could shift but here's what i've learned in 35 years of investing you can disagree with markets but don't you have to respect them and i respect markets i'm not a market diamond i watch markets and say maybe markets are wrong but i don't have the ammunition to tell you that they're wrong so on markets i just take markets as given because i'm a stock picker i'm going to go find stocks that i think are good investments no matter what the market is though so my suggestion is don't fight markets in fact uh one of the things i said last week or to a to an audience was they don't project your feelings onto the market and what i meant by that is i've been getting emails from people saying how come the market is so stupid how come the market's not seeing what i'm seeing i'm saying hey the market's seen you're what you're seeing and what a million other people are seeing that's the market's job so don't convince yourself your right and the rest of the world is wrong because the track record of people who do that is not very good professor you've always maintained that one should not get carried away with what the fed action is because in your previous or in our previous interactions you always said that fed's power are perhaps more in terms of perception rather in terms of the ability and action but right now everyone in the financial market is clearly of the view that if you have to choose between fighting the fed or the fundamentals don't fight the fed and that also explains why financial markets have gone higher because the general view is that central bankers will act as a backstop i think one of the problems with narratives without data is you can tell whatever story you want i call these fairy tales here's why the story doesn't hold up treasury rates in the u.s dropped in the first two weeks of this crisis which is february 14 through february 28th the almost all of the drop in treasury rates happened those two weeks you know the fed first started acting was in march so by the time the feds started acting markets had already marked down the treasury rate so if your argument is the fed somehow came in and bailed the market out i don't see that in the data because the rate drop happened before the fed came in i do believe that the fed has played its cards very well in this crisis and what i mean by that is the power of the fed comes from the perception that it has power it's got to preserve that perception so sometime in first to second week of march the fed announced a lot of fanfare that they might provide a backstop in the corporate bond market it's something the fed usually doesn't do it's a huge market you don't want the fed pw they announced that they'd be a bad backstop you know how much money they've actually spent being a backstop nothing because what it did though was create enough faith in the system that private lenders were willing to lend to boeing and the airlines what's been unique about this crisis is that the private risk-taking market whether it's equity or debt has not dried up unlike 2008 and i think the fed playing its cards right contributed to allowing capital to flow and one reason the market is so upbeat is one of the biggest words at the very bottom the market the middle of march was that you'd have a ton of defaults not just of small companies but of big oil companies airlines boeing that they would and that fear has faded into the background and part of the reason it's stated is because these companies have been able to raise capital singapore airlines a week and a half ago raised equity i mean in the billions of dollars and that is not something you usually are able to do in a crisis but that i think is one factor where the fed can have an effect but the fed's got to have a light touch if it tries to be heavy-handed and this is true for any central bank the perception will vary quickly a lot of us follow your blogs quite religiously sometimes there are some topics which you all you mentioned in your blog they in a sense really open your eyes and your latest blog piece on what is growth investing and what is uh value investing has got a lot of people uh thinking again in this new normal your blog and your work seems to be indicating that value investing is dead but that's a very powerful statement coming from someone who is the dean of valuations feels that the classic way of buy cheap and then sit on it for years and then markets will reward because you bought an asset at a lower price you think that typical old school value investing is over i think this is unique in global history when have we ever shut the global economy down completely for multiple weeks and for a period between march and early april the entire global economy was shut down that has never happened before the 2008 crisis was primarily a developed market crisis because emerging markets were relatively uneffective and you take every crisis and you go back in time you've never had a crisis with the entire global economy has been shut down and because of that all of the numbers that you're seeing are going to be numbers that are almost unusable unemployment of course the unemployment issue going to shoot through the roof you know why because you look out of your window what do you see everybody around you is not working either how can unemployment not go up consumer confidence of course it's going to collapse it's not just consumer confidence is collapsing you're feeling people's psyches under siege because you're stuck at home so one of the things about this crisis that makes it different is you you get no indicators by looking at macroeconomic numbers because usually the the way you know it in a crisis is companies start to lay off people as they get less confident that didn't happen here everybody had to lay off people right at the start of the crisis so i think that this crisis is unique in the sense that it's a global economic shutdown and none of us knows how the global economy is going to behave when we start the engine back up again that's where the optimism of the pessimists should be disagreeing it's not about what will happen in 2020 there's consensus that 2020 is going to be an awful year there is no way around it how can it not be through a retail store and force you to shut down for an entire quarter your revenues and earnings are going to reflect that the real question is what will happen after the crisis passes now what happened not just in 2021 but all the way through 2025 in fact i've been valuing the market off and on for the last 10 weeks and there are two big numbers i need to forecast to value the market one is how much will 2020 earnings be affected and the answer is you know a huge amount but the second and more important question is how much of that loss will come back in the four years following how much do that loss will be recovered because you're not going to get 100 of the recovery back why because if you skip a haircut during these 12 weeks you don't take three haircuts right after you come out of the crisis to make up so there's some services that will forever lose revenue so there's going to be some lost revenue that's not coming back it's a second question we should be focusing on when we think about what we think about markets not just about 2020 but what will happen in the aftermath and i think that requires we take our eyes off the crisis and think about what's coming after okay professor i want to go back to that whole question of value investing like i mentioned that you know all of us read and follow your blog or your blog post very closely in your latest block piece you are raising what perhaps has not been raised before by anyone what you are raising is that in this new normal value investing is dead you are you know you actually have some data in your blog post which seems to be suggesting that if one really looks at the comeback stocks in the post covered world they are not value or high dividend yielding stock now that's a very powerful comment or a statement or an indication coming from someone who is known as dean of valuations now in in my view you know value investing in royalty investing has become it's become a very lazy categorization yourself if you ask even value growth investors what they do here's how they describe themselves value investors say we buy stocks but i mean they quote ben graham to you and security analysis and warren buffett and you know charlie munger but the basis for old-time value investing has become i'm going to buy stocks that trade at low p e ratios or low multiples of book value and call it value investing yes growth investors what they mean by growth investing they're going to growth and earnings high growth and earnings high growth and revenues we we jump onto the bandwagon i think they both missed the book with that definition i mean can i value a growth company absolutely can i find a growth company to be undervalued why not i mean i've held tesla i've heard you know i hold facebook right now not portfolio none of neither of those stocks would fit a value investors classic definition but value investors are still stuck in the 20th century they think that book value actually means something i don't have much faith in accountants to begin with but i think book values completely lost its meaning what is the book value google even capture your biggest assets are off the books so i think the problem with value investing in growth investing is not the focus and value and growth but they don't really focus on either they focus on these metrics that they use as shortcuts and those metrics are lazy and part of the reason both groups of investors have kind of lost out to index funds is what you're doing is mechanical remember a machine is going to be much better at doing mechanical things than you are you know one of the reasons i wrote about value was is growth in this in the last blog post i had on the on the crisis its value has been losing out to growth for the last decade or so what i mean by that is the old-time value stocks low pe stocks high dividend yield stocks have underperformed high pe and no dividend paying stocks and for 10 years value investors have told us just wait wait for a crisis and then you're going to see value investing is going to come back well you have your chance now it's a crisis so i said okay let me go look at the numbers maybe this is when the payoff to buying low pe high dividend stocks is you're going to see the payoff it's in a crisis and what i discovered is in this crisis at least it's perverse the stocks that are being hurt the most are low p high dividend yield stocks so if you're a value investor your last and your piece of ammunition is being taken away if this isn't a wake-up call for old-time value investing i don't know what will be because i think they're stuck in metrics that really don't work anymore but professor when some of the marquee investors like buffett sam zeal harvard marks stanley draco miller all of them are clearly indicating and suggesting that markets have run up ahead of themselves which is that markets are here and valuations are here and there is a disconnect and valuations are unlikely to expand given the shape of the economy which means markets need to come down now these are experienced guys who understand the power of leverage who understand how to differentiate between value and growth and we also understand that what is the right time to take risk and what is the time right time not to take risk why do you think some of the smartest wall street investors who have been successful who are masters of the craft all of them are indicating and suggesting that markets should come down now i i think you know in a sense i mean let's say warren buffett he is he's not just a great value investor people invalid investing freedom like a god every word that comes out of his mouth they hang on to and i did listen to warren buffett talk to them because he gave his online berkshire hathaway talk which he usually gives at his woodstock and omar our people show up and as i watched him talk my sense was this is a 90 year old he stopped he's he looks like a 90 year old he talks like a 90 year old there's nothing wrong i'd like to be 90 years old you know you have to pay he to to age but he looked uncertain he looked unclear about what was going on and who can blame him so when i when i went back and looked at the substance of what he was saying and there was very little he said people might not fly as much anymore really this is the inside i'm going to get by listening warren buffett therefore i'm going to sell i don't make that leap i don't see how people not flying as much means that all airlines are are going to be bad investments it might actually you know make the airline business a better business if some of these airlines dropped off in the coin in this game so i think that you know it's not that these investors are not successfully invested not that they have they have nothing of wisdom to offer to us is we have to stop treating everything they say as gospel and start questioning i tell people in my class don't think anything i say as right question because that is really how you become a better investor you have to take watch out for yourself you have to come up with a way of thinking about markets that's unique to you you can't parrot somebody else so i don't care how great an investor's history has been or how wise they are i will listen to them but it's my job to create my own perspective on market that fits me as a person so professor do you think a genuine investor who is in for the long haul and is looking at allocating capital because when you're allocating capital you're also trying to associate or with the with the future should keep it simple and one should continue to invest in the u.s tech joints like apple alphabet netflix and to a large extent microsoft because that's where the new digital world alignment will happen and that's where the price strength and the concentration clearly seems to be the highest in fact it's it's not that difficult to think of what the post-viral economy is going to be going to look like right because what is this crisis shown us it's shown as the benefits of having a model that scales up quickly and scales down quickly the benefits of having a model with flexibility the benefits of having a model with size so in a sense you can see what this crisis is already doing is it's strengthening these companies in a way that will make them actually more powerful companies than they would have been without the crisis and people often talk about amazon and they talk about how the dot-com boom was what made amazon they're wrong you know what made amazon the company it is today it's a dot-com bust because what happened during the bust in 2001 was all of amazon's competition got wiped out all of the traditional brick and mortar retailers gave up on online retailing saying it doesn't work look look at the dot-com crash and they allowed amazon to become the largest i mean one of the most largest most successful companies in the world i think something similar is going to come out of this crisis i think in this crisis we look at the automobile business in a strange and perverse way this crisis has made companies like tesla which essentially did not spend the money building huge assembly lines and creating large fixed costs it's going to make companies like tesla more powerful at the expense of the tata motors the traditional automobile automobile companies which have large fixed costs huge assembly lines so i think you know now you can start thinking about you you got to almost think about a post-viral economy i'm a great believer in storytelling and one of the questions i i ask people to to think through is what was your story for this company before the crisis and what will your story look like after the crisis for a company like zoom that's easy the story before the crisis was it's a it's a company that serves the online business meeting market and that market wasn't a very big one it was about 90 to 20 billion dollars globally as a total market so even if you make zoom a very successful company its revenues have been eight to ten billion post crisis i see zoom as a much bigger more successful company why because more people are going to have online business meetings but it's also the platform of choice for online education or online anything you might do so the story i'm going to tell for zoom is going to be a much more expensive more successful story than the story i'd have told before the crisis and i would encourage people to do that go through that exercise pick a company and ask what was the story before the crisis what is the story after the crisis here's the final question this is the critical one will my company make it to that post-crisis economy and that's where debt has become this this anchor on companies because if you borrowed money you in a sense created this potential that you will not make something that lots of people in valuation kind of gloss over but you cannot gloss over it now so professor let's talk about financials banks traditionally markets have only used two metrics to value them which is price to book or pe in price to book its asset manage liabilities in price to earnings you look at the underlying growth how does one go about valuing financials when the world is going to be deleveraging but on the other hand the global central bankers and global governments would be leveraging the balance sheet what is the right way to understand where good quality financials stroke banking stocks are headed because globally these talks professor we all know that not only they are underperforming they are getting smoked they are clearly on the butcher block i think financials always live in reflected glory or reflected pain and in a strange way they're at the epicenter of this crisis they're going to get very little of the upside from the crisis right it's not like retail or technology where you see shifts but take it all on the downside it's an asymmetric game for financials since they don't get upset because most you're going to get paid is your bank loan with interest and you get all of the downside crises like these affect financials more than any other sector so it's not unique that this crisis you're seeing this that said though i think banks this might be one sector where banks are not being as discriminating as they should be because i think that if you're a bank and your loans are to oil companies and to you know real estate companies i should worry a lot more than if you're a bank with um with loans to more traditional manufacturing consumer you know consumer durables things that are consumer staples or healthcare companies so i think that financials are being affected because of the fact that they have an asymmetric payoff they get little of the upside from the economy improving their all of the downside so it's that reflected pain you're seeing in financials and as the fear of default starts to fade you should start to see financials come back so you think about investing in financials i would start researching my banks to see which banks have less exposure to the worst sectors and we know what those are big oil companies big infrastructure companies and then start investing in those companies a little ahead of the market because that that that come back is almost for you can foresee it you know three months six months nine months from now as the fear of default rises your view professor on the startup world startup for companies were pretty much working on borrowed capital they were losing money their investors were in a sense you know investing them with the assumption that they would be disruptive and they would be able to gain market share given that the entire start put startup economy is in some kind of a shock do you think startups now uh will find it difficult to revive and very few will actually survive see what the startup models have this advantage of being able to scale down quickly so an uber or a lyft they're so acid like that they can reduce their cost structure pretty quickly that said though many of these startup companies require capital to keep growing so very dependent not just on surviving but being able to raise capital in markets next year two years out three years out and one of one of your worries in a crisis is when that capital starts to dry up luckily that hasn't happened as much in this crisis as in prior crises to give you an example the last quarter of 2008 vc money completely dried up there was no vc money to be had in this crisis vcs have actually been willing to invest on their terms which means if you're going to go out and raise capital now you're going to be giving up terms to vcs that you would never have given up in good times so two things are going to happen to startups one is some of them are going to run into cash funds and get acquired by companies with deep markets and that's why i said this is the kind of crisis that strengthens the amazons or googles or facebooks of the world why because they're big and they have huge amounts of cash they're going to be able to snap up these companies at fractions of what they would be paying in good times the other is startups that actually can scale down enough that they could keep their head low do what amazon did in 2001. people forget how close to the edge amazon came in 2001 of going bankrupt they survived until they were in a position of strength and then they were able to go back to markets to raise capital so i think that that for those startups that can make it through keep their head low not have to access capital now it's it's going to be much better for them to raise capital a year from now or even six months from that then to try to do it right now so i think what this crisis is going to do is it's going to expose those startup models which are which are terrible business models from those that actually have some substance there because the ones that substance are going to be able to make it through survive and then go out and raise capital how has this crisis changed ashwath damodaran the teacher and has made ashwath damodaran the slightly more resilient i think in a sense every crisis humbles me more because it tells me it reminds me of how much i don't know for instance i used to tell people well when you look at price there's the lower bound is zero on the upper bound there's no upper bound you know what this crisis taught me that the lower bound doesn't have to be zero on april 19th oil prices drop below zero if you'd asked me six months ago can price drop below zero i said why would you pay people to take oil off your heads we saw why it was actually a very rational explanation you'd run out of storage space so one of the things i do during crisis and i would encourage people to do this as well as i keep a journal and i write in the journal what happened during a day that surprised me and because you forget six months later nine months later everything seems obvious because you've seen the pathway of history but you got to kind of put things down on paper when you feel most uncertain one of the reasons i've been right writing my update post and i'm on to post date i'm just writing post nine is not for other people it's for me it's really for me to work through the things that i'm uncertain about so what this crisis has brought home is there's so much more for me to learn and i don't want crises to be the way i always learn so i've got to keep the door open no evaluation i've described as a craft and i'm still really working on that craft so this crisis has delivered that message and it's allowed me to kind of finesse or get better at some parts of the crowd and that's the lesson i hope i try to convey in my classroom so i don't have the answers but i'm going to keep looking because if you keep looking you get better at finding the ads might not be the right answer but a better one professor the minute somebody says finance we start thinking about balance sheets numbers lot of analysis and sometimes very boring analysis but you've converted the art of valuation into storytelling like you told us a story on ola last time when we met oh sorry uber last time when we met to use you know spoke about the amazon story so how have you managed to convert what could be a boring subject into nice storytelling uh module i think that it's made finance in general is made complex by practitioners who need to make it complex the same reason you're going to a doctor and you have something and he tells you you have this and he said what the heck is that he says well that's you know it's a flu but he calls it something else he has to call i mean any specialist has to attach a name to things that are foreign to people or not in the profession why because that's the way you make your profession look profound i think we've spent 50 years in finance adding complexities we collectively as bankers academics consultants adding complexities to make the rest of the world need us my job in a sense is strip away those complexities and make myself dispensable i tell people look you don't need me to value company you already know how to value a company all i will do is give you a framework that makes it easy for you to see what you already know and guess what we all know finance we get it intuitively instinctively when we're young kids and somehow during the process of taking finance classes we actually get further away from that understanding than closer so what i view my job as being is being is telling people what they already know in a way that they said ah i knew that already and i said i've accomplished my objective so hopefully i can keep doing that so professor if you have to really let's say summarize your 30 years of teaching hours and hours of hours and hours you've spent in analyzing companies you've mastered the art of valuation who is one person over the course of year over the course of your career has influenced you the most which is that when this financial person or non-financial person when he or she writes speaks or indicates something you really want to you know focus and concentrate on that you're going to be surprised by the name i give you because it's not a name that any value investor will ever raise jack bogar jack bogle of course founded vanguard he founded the index fund business and i tell people you know what jack vogel has saved more money in his lifetime than warren buffett can can make for other people in 10 lifetimes we celebrate people who tell you to act to buy stocks we don't celebrate those people saying look you're wasting your money paying this mutual fund manager two percent of your money every year for doing nothing i mean i have very few heroes but jack bogle is one of those people you know i i listened to and said he was the original disrupter even more people like him pointing to the truth saying hey you know what this isn't working because we we if we pay too much respect to the status quo in every single profession and he was the original disrupter so professor i'm just tempting to ask you one more question i promise the final one so are you indicating and suggesting to our viewers that index investing is the way forward it could be nifty for indian investors it could be s p for american investors but go for index investing because that's low cost and index investing is no promise in index investing you are buying the promise to buy future returns at a very low cost well they make whatever the market makes that's the thing about index investing they're not making any promises they cannot keep they're making a promise that you will get whatever the market makes and guess what for most of us that's very good advice investing is not about making money it's about preserving and growing your savings and your wealth so if you're a doctor or an engineer you don't go out and on a limb and pick three stocks because warren buffett did it put your money in the next one go back to making money as a doctor or an engineer so i think that index funds actually don't promise anything they just say look you know you will get whatever the market makes good or bad and that's actually not a bad thing to do because what does the average active money manager deliver to you one and a half percent less than that this is a strange profession i'm money management where it's i mean the analogy i give in class in class is right running a plumbing business is called floods or us and here's how the business works you have a leak in your house you call in the plumber and he leaves a flood how long will you stay in business that's what active money management has been doing for as long as it's been around it's going into houses with leaks and leaving a flood and demanding to get paid for creating the flood and i think that index funds have revealed the emptiness of a lot of active investing and you know that's a good thing stay safe really appreciate your time we've really covered a range of subjects today on what is the meaning of value investing uh how should one understand the technology and banking stocks and the last one i think very crucial for investors that if you're in for long haul it may not really hurt if you allocate some capital to pure index stroke etf investing appreciate your time professor let's take a break market

Channel: ET NOW

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Keywords: Businesses During COVID, Aswath Damodaran, COVID crisis, low consumer confidence, index investing, fund managers, et now, exclusive interview, valuation decoded, Value investing, growth investing, coronavirus impact, covid 19 impact

Id: 4_uhuTdpl5Y

Length: 32min 36sec (1956 seconds)

Published: Fri May 29 2020