[MUSIC PLAYING]
SPEAKER 1: Hello, everyone.
Aswath Damodaran is
here and I couldn't
be more pleased
because I have learned
a lot about investment valuation
from just reading his blogs.
I think he is one person
who has single-handedly made
investment valuation open source
and available to all of us.
In addition to his
original classroom at NYU,
he also has a virtual classroom
on YouTube of tens of thousands
of students spread
all over the world.
And one thing I really
admire about Aswath
is that he does not shy away
from discussing current ideas
and let them be examined
over time in real time.
He's also somebody who has
been very open and transparent
about sharing
investment mistakes,
which you don't really
see in the investment
community in general.
I think they're the really
special thing about professor
is that he brings the side
of an academic and bridges it
all the way to that
of a practitioner
and does it in a very
open, candid way.
He's written phenomenal
books about investing
and today he is here
to discuss with us
the latest in the
edition of books, which
is "Narrative and Numbers."
So without any further ado,
I am very delighted, please
join me in welcoming
Professor Aswath Damodaran.
ASWATH DAMODARAN: Thank you.
[APPLAUSE]
So let me start with a story.
I came to NYU in 1986,
that was when I was hired
as an assistant professor.
And I was given a class to teach
called security analysis, which
is an old class with
a collection of topics
that I chose to replace
with a valuation class.
I actually didn't tell
them I was doing it,
I just went into the class
and made it a valuation class.
And that was 1986.
This will be my 31st year
teaching valuation, my 53rd
semester.
And everything I
know about valuation
I've learned in the course
of teaching this class.
So one of the lessons
I'd like to talk about
is something I didn't know when
I started teaching this class
that I had to teach myself.
So I'm going to take you on a
personal journey on something
I had to learn to do better
to actually do valuation.
So I'm going to start
out with a question
that I start off every
one of my classes.
Let me give you a sense of
what my classes look like.
I have a typical
class of about 300.
It's an MBA class,
it's about 300 people
who walk into the room.
And if you're familiar with
how MBA programs have evolved,
they've become more
and more diverse.
So I've got not just bankers,
but I've got museum directors,
I've got ballet dancers
and NBA players.
In a sense, it's a
very diverse classroom.
So here's one of the first
questions I ask them,
and I'm going to start off this
session with that question.
There's no right answer,
don't look at your neighbor.
So here's my question.
If I asked you to classify
yourself as a person,
would you more naturally
think of yourself
as a storyteller or
a number cruncher?
Think about it
for just a moment.
What comes more naturally
to you, storytelling
or number crunching?
Howard, I know you've
known for a long time,
so you probably knew.
I'll tell you when I knew.
I knew when I was
about 13 or 14,
right after my first
English literature class.
And I was asked to read
"Moby Dick," and I did.
And I was ready for the
discussion, ready to talk
about whales and captains.
So I show up in class ready to
talk about whales and captains
and there's nary a mention
of whales or captains.
And about 15 minutes
into the session,
the instructor says,
there was no whale.
And so what?
I distinctly remember a big
black fish going all the way
through the book.
And then she started talking
about hidden meanings
in the book and I remember
sitting there saying, really?
That's what Herman Melville was
thinking when he wrote that?
And my reaction when I
came out of that class
was, never again am I
going to subject myself
to this kind of bullshit.
And my life was
laid out for me--
it was Algebra I,
Algebra II, Algebra III,
out of high school.
And these were the good old days
when you could go to college
and not have to deal with the
crap you have to do today--
core curriculum,
you know where they
make you take classes for two
years you never want to take.
Those days, you could take
numbers class, numbers class,
numbers class, numbers
degree out there.
And then you had a numbers job--
you were a banker, an engineer.
And after about four
years of entering numbers
into spreadsheets, you
got incredibly bored so
what did you do?
Come back to business
school, you're in that class.
About 180 people in my
class are number crunchers,
recovering number crunchers.
But there were people
in that literature class
who loved this
hidden meaning stuff.
I've never understood them.
They're the poets.
My youngest son is a poet.
He showed me his
first poem and I
don't think he's going to show
me too many poems after this
because he showed me the
poem and I said, [INAUDIBLE],
I think there's a problem.
Aren't the last words
supposed to rhyme?
He said, Dad, you're not a poet,
that's why you don't get this.
I said, you're right.
But there were people who loved
this hidden meaning stuff.
They took Literature I,
Literature II, Literature III,
became history majors
at Yale, went to work,
and discovered that even
Yale history majors don't
get paid very much.
So after about three years
of poverty-stricken lives,
they come back to
business school,
they're the other 120
people in my class.
That's roughly speaking what
my class breaks down into,
60% number crunchers,
40% storytellers.
And once this
classification happens,
the number crunchers
start to preen.
They say, what the hell are
you guys doing in this class?
This is a numbers class,
it's a valuation class.
And that's when I
let them in on what
I think is the biggest
hidden secret in valuation.
Valuation can never be
just about the numbers.
If you have just a collection
of numbers in a spreadsheet,
you just have a collection
of numbers in a spreadsheet.
To me valuation, is a bridge
between stories and numbers.
And let me explain
what I mean by that.
When you show me a valuation,
I point to a number
and ask you, why is that number
what it is, I need your story.
And when you tell me a
story about a company, about
great management,
about a brand name
and I say, what does that story
mean, I need to hear a number.
Good valuations
bridge that divide.
And it is what--
I mean, I know this word
is going to sound strange
in the context of valuation.
The story is what gives
soul to your valuation.
A valuation, that's
a spreadsheet.
The story is what gives
your valuation a soul.
And here's where my
personal journey begins.
I started teaching the
valuation class in '86.
And when I first
started teaching it,
I taught it as a number
cruncher does, which is what?
All numbers all the time.
When in doubt, add an equation.
You're in further doubt,
add two equations.
That's how number
crunchers think.
And about six years
into the process,
I discovered I had no
faith in my own valuations,
another word you don't see
in the context of valuations,
right?
And here's what I mean about
faith in your own valuations.
When you value a company,
especially if you're not
being paid to do the valuation,
why do we value companies?
It's not because we're
intellectually curious.
I don't lie awake and
say, I wonder what
Facebook is worth right now.
If you do, see a psychiatrist.
I value companies because I
want to act on those valuations
in what sense?
If I find something
to be undervalued,
I need to be able to
buy that stock, right?
And what I discovered about
six years into this process was
I could value a
company, but I wasn't
willing to act because I knew
it's a collection of numbers.
I knew how easily I
could make those numbers
move if I wanted to, make
that revenue growth from--
I could hide my biases
all over the place
and you would never find it.
That's when I started thinking
about what am I missing?
And what I found I was
missing was the capacity
to tell a story.
So what I'd like to do is
take you on this journey
because if you're
a number cruncher,
you have some
delusions to overcome
and if you're a storyteller, you
have your own set of delusions.
So let me ask this room that
question, how many of you
are natural number crunchers?
So let me list some delusions.
Let's see if we share
these delusions.
The first is the
delusion of precision.
The way I describe this is when
a number cruncher is in doubt,
you know what he or she does?
Adds decimals.
It makes you feel
much better, right?
Three decimals,
maybe make it five--
delusion of precision.
The second is the delusion
that you being objective.
Why-- I just use numbers,
I'm not being biased.
And the third is the
delusion of being in control.
Just because you have
a number for something
doesn't mean you control
it, but it gives you
the delusion of control.
Those are the number
cruncher's delusions.
If you're a storyteller, you
have your own set of delusions
and here are some
of those delusions.
The first is you
think being creative
should bring its own reward.
I told you such
a great story, it
should be worth at
least $3 billion, right?
You think number crunchers
dream in black and white,
they're incapable of
dreaming in color,
they have no imaginations.
And you love anecdotal evidence.
You're like my
mother-in-law, and I don't
mean that as a compliment.
She comes up with the most
outlandish conclusions.
You wonder, where
did that come from?
I'll give you an example.
About 10 years ago,
she mentions in passing
that the best car to drive in a
snowstorm is a Volkswagen bug,
you know the old ones
that you could pick up
with two errands and move?
I said, how do you
come up with this?
And she told me--
I should never ask her, how
do you come up with this
because she always tells me.
She said 25 years
ago she was driving
in Lake Tahoe in a Volkswagen
bug in a snowstorm.
There were two cars in front
of her which went off the road
and she made it back home.
Therefore, a
Volkswagen bug is the--
sample size of one.
Amazing how you can
extrapolate from there.
So when I look at my 300
students, I tell them,
this is what I hope this
class will do for you.
I turned to the
storytellers first and say,
by the end of this
class, I hope you
learn enough number
crunching skills
to develop some discipline.
Because when you tell
stories, you sometimes get
carried away, right?
You wander across that line
between fact and fantasy
and you're not even sure that
you walked across the line.
I hope you develop enough
number crunching that you know
that you're crossing the line.
I hope that you become
disciplined storytellers.
Then I turn to my
number crunchers
and say, by the
end of this class,
I hope you trust
your imagination.
To me, that is the
essence of somebody
who's good at valuation,
disciplined storytellers
or imaginative number crunchers.
So let me ask you a final
question before we move on.
Who do you think I
have more trouble with,
getting storytellers to develop
discipline or number crunchers
to trust their imagination?
It's not even close--
number crunchers.
You give me 100
history majors, I
can teach them enough
valuation in a day
that they're going
to be OK tomorrow.
You give me 100 engineers,
I'll give up right away.
You guys are beyond
redemption because you've
spent your entire lifetime
bludgeoning your imagination
into the ground.
You don't trust it anymore.
So to me, this is
the key to valuation
is working on your weak side.
I know it's a legend about the
left brain and the right brain,
but if that legend is true
that the left brain controls
logic and the right
brain, why are you
using only half a brain?
It's tough enough
using your entire brain
and doing things right.
If you trust only
half your brain,
you're not using the other half.
So what I'd like
to do is take you
on my journey of how I
taught myself storytelling.
And I'm going to take
you through five steps
that I go through to
get to a valuation.
Why five steps?
Because I'm a number
cruncher, I think linearly.
I have to think in steps.
If you're not a number
cruncher, jumble them all up.
It doesn't matter the sequence.
So here are the five steps
I'm going to take you through.
I'm going to start
off by telling you
a story about a company.
And to tell a story
about a company,
you know what, I
need to understand
what the company does.
If I think Cisco
makes vegetable oil,
the story I'm going to
tell you about Cisco
is going to make
no sense at all.
So that common
sense wisdom you're
given, you've got to understand
a business to value it,
that applies in spades.
I've got to tell you a
story about the company.
Second step, I've
got to stop and make
sure the story I've told
is not a fairy tale.
I've got to ask three
questions-- is it possible, is
it plausible, is it probable?
Sounds like I'm playing
on words, right?
Which is the weakest test--
possible, plausible,
or probable?
Possible.
Lots of things are possible.
A subset of those are plausible.
An even smaller
subset are probable.
For every 100 business stories
I hear, maybe 15 are plausible
and five are probable.
I'll give you a very simple
way of thinking about possible,
plausible, and probable.
Any San Francisco
Giants fans here?
Nobody?
OK.
Any Yankee fans here?
I'm a Yankee fan.
OK, they're 10 and
five right now.
I'm feeling very good.
Is it possible that they could
go 157 and five this season?
There are 162 games
in a baseball season,
you don't know.
Is it possible?
Yes, it's possible.
Is it plausible?
No.
Why not?
No team in history has ever
won 147 games in a row, ever.
It's possible,
but not plausible,
and it's definitely
not probable.
Three different levels of tests.
Once I've established that my
story is possible, plausible,
and probable comes what I call
the craft part of valuation.
And here's what I mean
by the craft part.
I have to be able to take
every part of my story
and make it into a
number in my valuation.
And you say, what if my
story can't become a number?
I view it as a challenge
when somebody says,
I have a variable you can't
or I have a story you can't--
you tell me a story, I'll find
the number and a valuation
to reflect it.
And once I convert my
story into numbers,
the valuation does itself.
By the time you look
at the valuation,
it's my story that's
driven the valuation.
so if you point to a
number in my valuation,
I should be able to back
it up with the story.
And then comes the
most difficult part.
So you've told this
great story, right?
Do you like your story?
Yeah, of course.
It's your story.
You've converted the
story into a valuation.
Do you like your valuation?
Absolutely.
And when you present
that valuation
to other people, what do
you want them to tell you?
This is amazing.
This is exactly the way
I'll value the company.
So here is my
advice to you, don't
talk to people who
think just like you.
Don't hang out with
people who think just
like you because they're
going to say, this is amazing.
This is exactly how I'd
value the company, too.
So here's what I call keeping
the feedback loop open.
Seek out people who
think the least like you.
When you present your
valuation to them,
you know what they're
going to say, right?
This is horrible, this is a
stupid way to value a company.
Listen because they might
be telling you things that
can make your story better.
So what I'm going to do
is take two companies
through this process so you
can see this game play out.
And the two companies
I'm going to use I
know you're familiar with.
And the reason I'm going to pick
familiar companies is here's
what I'd like you to do.
As I tell my story,
I'd like you to think
about how wrong my story is.
So I want you to
think about what
you disagree with my story,
but don't interrupt me.
This is my story, my turn.
But after I'm done, I'm going to
give you an architecture where
you can take your story
about these companies
and make them with
your valuations.
To me, that is the
essence of investing
is you take ownership
of your own stories.
So here are the two
companies I'm going to use.
The first is Uber
in June of 2014.
So why does the timing matter?
Because my story for
Uber shifts over time.
Why does it shift?
Because the world
shifts around me.
So I've actually on my blog
valued Uber in June of 2014,
September of 2015, September of
2016, and I plan to do it again
in a month.
And my stories change
and I have no shame
about admitting the fact that
my stories change all the time.
The second company
I'm going to value
is Ferrari in
October of 2015, just
before their initial
public offering.
Ferrari has actually been around
a long time, since the 1940s.
But in the 1960s, Enzo
Ferrari got into some trouble
and he had to sell off 90%
of Ferrari to Fiat Chrysler
and for about 50
years, Ferrari stayed
as a part of Fiat Chrysler,
until 2015 when it was spun off
as an independent company.
So I'm sure everybody
in this room
is at least familiar
with what Uber does
and what Ferrari does.
So these are stories that should
have a hint of familiarity
to you.
So let's start the game.
The first step in the process
before I tell a story is I
need to understand the company,
understand the business.
One of my problems with the
way research has evolved,
it's become too much around
financial statements.
When I ask you to do
research, what do you do?
You collect
financial statements.
And the other thing
that's become a problem
is Google search
because when I ask you
to do research, what do you?
You type the name of the
company, hundreds of articles
pop up.
That's not a bad place to
start, but it should never
be the place you end.
You know you learn
more about a company?
Talk to people.
Talk to people who
use the product,
talk to people who
work at the company.
You need to understand
what the company does,
what makes it tick, to
be able to value it.
So I'm going to tell you
when I first heard of Uber
and when I say this,
you're going to laugh.
You'll say, you didn't
hear about it until then?
I heard about Uber
in June of 2014.
You're saying, what were you
doing, living under a rock?
I was actually
living underground.
Because I live in New York
City, I take the subway, I never
take the surface roads.
Because who wants to
deal with the traffic?
So I see this new story in
the "Wall Street Journal"
that says Uber has been
priced by a venture capitalist
at $17 billion.
Notice the word I used.
I used the word priced,
not the word valued.
So let me put this on the table.
No venture capitalist in history
has ever valued anything,
they have priced things.
It's a very different
game because the way
you win as a venture capitalist,
you buy at a low price,
you flip it to somebody
else at a high price.
They had priced
it at $17 billion.
And I said I hadn't
heard of Uber,
but that was a bit of a lie.
I'd seen the word Uber on
my credit card statements
in the three months
leading into June of 2014
because it turned out that my
son, who was going to college
in North Carolina,
was using Uber
and using my credit
card to back it.
I don't know how that happened.
But I thought he was taking
German language classes,
to be quite honest.
the no umlaut on the U should
have kind of given it away.
So I called him, but
he was still sleeping.
It's like 11:30 in the
morning, college student hours,
which means you go to bed at
like 5:00, you wake up at noon.
So I called my niece,
who worked in Chicago,
and she was on her way to
work and not in a good mood.
So I said, what's this Uber?
She said, it's a
ride-sharing service.
I said, what the heck is
a ride-sharing service?
She said, I don't have
the time to tell you.
Why don't you just download the
app and find out for yourself?
So I hang up the phone,
I download the app,
and I hit the app.
Magical things start
to happen on my phone.
I see a GPS open up and I see
a car trying to get to me.
It's New York City--
you only try to
get to a place, you
don't actually get there because
it's all one-way streets.
And I could see a
guy called George
sitting in the front seat.
This has never happened
to me with a yellow cab.
The car pulls up, I run out to
the car and say, hi, George.
He says, where do
you want to go?
I said, I don't
want to go anywhere.
Can you drive me around
for about 30 or 40 minutes?
I have some
questions to ask you.
[LAUGHTER]
He thought I was
a serial killer,
but then he took one look at me
and said, I can take this guy.
Get in the backseat.
So I get in the back seat I
start asking him questions.
I said, this is an Uber
car you're driving?
He said, no.
This is my car.
I said, are you
an Uber employee?
He said, I'm an
independent contractor.
I said, why do you do this?
He says, I have a regular job.
I don't make enough
money and this
allows me to make a
second income in a car
that I already own.
I said, why do you need Uber?
He said, without Uber, I can't
pick up people in the street.
It's illegal in New York City to
pull up to somebody in the curb
and say, do you want a ride?
Uber is my matchmaker.
So at this stage,
I could understand
why this guy used Uber,
because it allowed him to take
a car he already owned--
in fact, I asked him, do
you pay extra insurance?
He said, I don't mention it
to the insurance company.
What they don't know,
they don't know.
So basically, he
was taking the car,
he was using the
insurance he already had
and making a second income
and Uber was the matchmaker
that allowed him to do it.
So he lets me off in
front of my office.
I offer to pay him.
He should have just
take the money.
He said, you don't
have to pay me.
I said, it's free?
He said, no, it's not free.
When you downloaded the
app, did they ask you
for a credit card number?
I said, yes, and bells
go off in my head.
They're going to charge you.
And I said, how do you get paid?
He said, they'll send me
80% of whatever the fare is.
I remember asking, why 80%?
He said, I don't know.
That's what they all do.
Now I could understand why
Uber did what they did.
For essentially
being matchmakers,
they collected 20%
of whatever you pay.
I said, this is
a great business.
Which left me with
one missing piece,
why do customers like Uber?
So this time, I called my
son at a civilized hour,
like 3:30 in the afternoon,
when he was awake.
And I decided to put him on
the defensive right away.
I said, I've been noticing
you've been using my credit
card to back up
your ride-sharing--
I made it sound like I knew what
Uber was doing all the time.
You have your own car,
why do you need Uber?
He said, Dad, on some
nights, I like Uber.
Some questions as a parent
you don't dig too deeply on.
I kind of got it.
But this is a kid I
can't even visualize
him calling a traditional cab.
It's not even in his
frame of reference
to go out on the street
and wa-- you know.
I said, what do you
like about Uber?
And he said, I can call
the car from my phone.
And I said, these cars must
cost you a lot more than a cab,
right?
He said, no, they're
cheaper than a cab.
I said, you must wait
a lot longer, right?
He said, no, no, they,
come faster than a cab.
I said, these cars
must be filthy, right?
They're cleaner than a cab.
I said, let me get
this straight--
they're cheaper than a cab,
they're faster than that cab,
they're cleaner than a cab.
That's when I knew cab
service was destined for doom.
We can dance around
as much as you want.
The final question I had
to clean up for myself was,
why couldn't I do
this in my basement?
I could be a matchmaker
just like Uber.
And there were three answers I
came up with in June of 2014.
The first was $3 billion.
That's how much they
raised from the VC.
I didn't have $3 billion.
That puts me at a disadvantage.
The second is this is a game
with a networking benefit,
you see what I mean?
As you sign up more
drivers, it becomes--
a new driver wants
to join, he's going
to go where the
rest of the drivers
are because the bigger
that space, the more likely
it is you'll get customers.
And the third is it is a company
that is using data in ways
that hadn't been used before.
Like what?
The surge pricing, for instance.
So when I talk about
understanding your company,
I'm essentially talking about
learning more about what
your company does-- why do
people like it's products,
why do they work for it--
and getting a sense of
what the business model is.
So to complete the story, after
I did this research-- if you
can call it that-- on
Uber, I drew a picture
and I try to do this with
almost every company I value,
a picture of what the company
does, what it produces,
who buys from the
company, why they do it.
In the case of Uber, what
completes the story is
they have a business model--
and I could see this
in June of 2014--
that is easily scalable.
You know what I mean
by easily scalable?
For Uber to go to a new
city, all they need to do
is hire one person, put
them in a motel room
and say, sign up as
many drivers as you can.
There's no infrastructure
investment.
They don't buy the cars, which
means they are going to--
it comes with
pluses and minuses.
It means they can grow
much faster, that's a plus.
What's a minus?
It means that other
people can use the same--
so it's a business that's
going to grow fast,
but it's going to be difficult
to defend and make money on.
I had a sense, at least, in
June of 2014 of what Uber did.
Let's turn to Ferrari.
Technically speaking,
it's a car company, right?
That's the bad news.
Why is it the bad news?
Because this is not a
great business to be in.
It's one of the 10 worst
businesses in the world
to be in.
That sounds like a
categorical statement,
but every year I actually
rank the 10 worst businesses.
Online advertising has not
made it there, so don't worry.
Your businesses are safe.
The automobile business
is an awful business.
Let me start laying out the
basis for that statement.
In the 10 years
leading up into 2015,
which is when
Ferrari went public,
the revenue growth at automobile
companies on an annual basis
globally was only about 5.6%.
That's it.
That's pretty anemic growth.
And half that growth comes from?
I tell my MBAs, when somebody
asks you a question you don't
know the answer to, say China.
[LAUGHTER]
It's amazing how often
that is a good answer.
Whatever the
question, China works.
Why are interest rates low?
China.
Why are interest rates high?
China.
Why is inflation going up?
China.
It's like six degrees of
separation from Kevin Bacon.
Every question, China is
within six degrees of hey,
that's the right answer.
So 5.6% growth, half
of it comes from China.
You're saying, so what?
If China slows down, the
5.6% is going to become 4%.
Operating margins are abysmal.
The average operating margin--
so this is not
net profit margin,
this is higher up in the
income statement-- is 4.4%.
And 1/3 of all automobile
companies lose money.
So you've got low
revenue growth,
you've got abysmal margins,
let's nail the coffin shut.
Normally, when you have
low revenue growth,
one of the few
bonuses you get is
you don't have to
reinvest very much.
But in the case of
automobile companies,
that is not true
because they've had
to reinvest not in
assembly lines, but in R&D.
Do you know why they
have to invest in R&D?
The modern car is more
computer than car,
so they had to invest
in R&D to catch up.
This is your definition of
a bad business-- low revenue
growth, abysmal margins,
lots of reinvestment.
The way this manifests itself
is in nine of the last 10 years
leading into 2015,
automobile companies
earned a return on capital
less than the cost of capital.
That's the bad news for Ferrari,
they're in a bad business.
The good news for
Ferrari is they're
not another car company, right?
In fact, I'm not even
sure if it's a car.
It's a very impractical car.
There's one guy in my
town owns a Ferrari,
I've never seen him drive it.
It's kept in an extra armored
garage with two security
guards in front.
You could break into his
house multiple times,
but his car is protected.
Rumor is once every year, he
takes the car out of the garage
and drives it around town,
back into the garage,
locks it up for the next year.
And who can blame the guy?
What are you going to do in your
Ferrari, go grocery shopping?
Can you imagine parking your
car, walking into the grocery?
AUDIENCE: A lot of
them, the insurance
covers only the weekends.
ASWATH DAMODARAN: There you go.
And even the
weekends, you probably
have to have two guards
running next to your car
to make sure nobody
is scratching your car
as you're driving it.
You can't go grocery--
how about carpool in a Ferrari?
You've got four kids
to pick up, one seat.
What are you going
to do, stack them up?
So why would people
spend all this money
to buy a car you
can't drive anywhere?
Because you're part of
a very exclusive club.
How exclusive?
Let me give you a picture.
In all of 2014, the year
leading into the IPO,
Ferrari sold 7,255
cars globally.
In the entire year, 7,255.
Think about that.
That's how many cars
Volkswagen probably rejects
on its assembly line every day.
7,255 the whole year,
that's bad news.
The good news is their
operating margin is 18.2%.
Remind me again what it was
or the rest of the automobile
business.
4.4%.
So why is their margin so high?
One answer is because they've
priced the car so high.
The other is they
spend almost nothing
on traditional advertising.
Have you ever seen
a Ferrari ad on TV?
Come on in, 10% off.
It's not the kind of
person they want coming in.
In fact, I'm not even sure
how you buy a Ferrari.
You walk in, the
dealer probably says,
do you have any references?
To what?
Billionaires you know.
You know no billionaires?
Get out of here.
It's an exclusive club, they
can't let the riffraff walk off
the street and buy a Ferrari.
So it's doesn't sell very
many cars, high margins.
And here is the final advantage.
Normally, when you sell these
high priced luxury goods
like Tiffany and Guccis, in
good times you sell a lot--
you're affected by the
economy, because people
are reaching to buy your stuff.
That's not been true at Ferrari.
They've sold about 7,200 cars in
the 10 years leading into 2014,
including 2009.
Know why I picked 2009?
The year after the crisis
you'd expect sales to drop off.
Nothing happened at Ferrari.
Why not?
The people who buy
Ferraris are so
rich that if you ask them,
what's the economy doing,
their response is,
what's an economy?
Because to them the
essence of a bad year
is I'm worth only $4.5 billion
instead of $7.5 billion-- not
exactly cutting corners
or cutting costs.
So the final bonus
you're getting
is you actually get pretty
stable revenues even though you
have this luxury product because
you've kept it so exclusive.
Those things are all going
to play out when I tell you
my story for Ferrari.
So let me talk about
business stories.
What exactly is a business
story, how should you tell it?
If any of you are entrepreneurs,
want to be entrepreneurs,
dream of being
entrepreneurs, take
this for whatever it's worth.
If you're telling a business
story, keep it simple.
As opposed to what?
Don't make yourself
so George RR Martin
and tell me a "Game
of Thrones" story.
I still remember trying to read
the first "Game of Thrones"
book.
About halfway
through, I gave up.
There are like
hundreds of characters.
They die.
They come back to life.
There are like six empires.
I said, I'm too old for this.
You tell a "Game
of Thrones"-- you
don't have seven
seasons and 70 episodes
to tell your business story,
you probably have five minutes.
Keep it simple and
keep it focused.
What's the end game
for every business?
You have to show me a
pathway to making money.
Pathway doesn't have
to be next year,
it might be seven
years from now.
So don't keep talking about
how many users you have.
That's nice.
Tell me how you plan to convert
these users into profits.
That might come
way down the road,
but without thinking
about it, it's
not going to magically happen.
So I'm going to try
to follow those rules
in trying to come up with
stories for Uber and Ferrari.
So in June of 2014, here was
the story I told for Uber.
And every word in the story
is going to have consequence,
so kind of hang in there.
I described Uber as an
urban car service company.
So already, I'm
trying to tell you
where I think Uber is
going to succeed, right?
Urban means cities
and big towns,
car services is
the basic business.
Remember I said I wanted
you to think about where
you disagree with my story?
So given where
Uber is now, start
thinking about that's wrong.
That's fine, but this is
my story in June of 2014,
an urban car service
company that's
going to attract new users
into the car service business.
Like whom?
Like my son, people who normally
never take a cab who have now
tried to take this car service.
With local networking
benefits, I've
already talked about what
networking benefits are.
As you become the largest
ride-sharing company
in New York, there's
a tipping point
where you're essentially
going to end up
dominating the market.
You think, what's the
local doing there?
Let's say Uber becomes
the largest car service
company in New York
and I fly to Chicago.
I don't care about the
largest car service
company in New York, I now care
about the largest car service
company in Chicago.
So in my story, here is
what's going to happen.
Uber can end up
dominating New York,
Lyft can end up
dominating Chicago,
Didi Chuxing can end
up dominating Beijing,
and Ola can end up
dominating Mumbai.
You think, so what?
When I start assigning
market share of the market,
this story is going
to come into play
as to what kind of market
share you're going to see.
And finally, I'm going
to assume that Uber
is going to be able
to continue to do what
it does now, which is what?
Not own the cars,
not hire the drivers,
which means that they
can scale up really fast.
And they're going to be
able to keep that 80-20 mix.
That's completely arbitrary.
Why not 85-15, 90-10, 95-5?
They're going to keep that mix.
So that was my Uber
story in June of 2014.
Here's my Ferrari story
in October of 2015,
at the time of their IPO.
I assumed that it would
stay in an exclusive club.
It doesn't have to, right?
It could pull what
I call a Maserati.
Maserati in 2008 looked
a lot like Ferrari,
it sold about 7,000
cars, had high margins.
But in 2009, Maserati
decided that they
wanted it to grow faster.
The way they did this, they
introduced a new Maserati,
a cheaper--
don't get too excited,
it's not that cheap--
called the Ghibli, going
after a bigger market.
And it succeeded.
In what sense?
Their growth jumped
to 15% a year.
That's the good news.
But what do you think
happened to their margins?
They went down because they
had to advertise, expend.
So they went from 18% to 14%.
And in addition,
you are now selling
to people who are rich
but not super rich.
So they actually knew
what the economy was doing
and stopped buying cars if
they felt the economy was not
doing that well.
So I'm going to
assume that Ferrari
is going to stay with
their exclusive club model
and not pull a Maserati.
Now comes that test where--
one of the biggest
things about stories
is your biggest
test is yourself.
You've got to make sure
that you ask of your story
the question before
somebody else asks it.
So is it possible, is it
plausible, is it probable?
The reason you ask that
question is probably
easy to build into
your cash flows, right?
There are all these
techniques we can use.
Plausible I can build
into growth, possible
I'll just wave my hands and
perhaps use some option pricing
to kind of bring it in.
But to illustrate what
I mean by possible,
plausible, probable, the
best way I can do this
is to flip it on
its head and talk
about implausible stories,
implausible stories,
and improbable stories.
I'll give you one example
of an impossible story.
Every person in my class has
to pick a company to value
and they can pick
whatever they want.
So about two years ago, one
of the students in my class
picks Netflix to value.
This is a company that is a
great company value-- exciting,
dynamic--
but a company where you
have to really stretch
to get the value up to the price
because it's a really richly
priced stock.
So it's trading
at 1.8, comes back
with a $500 value per share.
I'm flabbergasted.
So I look at the
numbers and he's
projected revenues of $600
billion for Netflix 10 years
from now.
So I call the kid in--
he wasn't even a kid,
he was 29 years old--
and I said, do you have Netflix?
He said, yes.
I said, how much do
you pay for a year?
He pulled out his
calculator, which seemed
to be attached to his hip.
He hits the numbers,
about $100 a year.
I said, how many
subscribers would you
need to get to $600
billion in revenues?
He pulls out this
calculator again.
I said, you don't need
a damn calculator.
Divide $600 billion
by $100, you've
got six billion subscribers.
He says, I don't see
where this is going.
I said, just hang in there.
I have a couple of
more questions for you.
I said, what's the
population of the world?
He says, I don't know.
I have to go check Wikipedia.
I said, I'll save
you the trouble.
It's about maybe six billion,
six and a half billion.
I said, is there something
I don't know maybe
that you should be telling me?
Maybe there's been a
law that's been passed
that says every man, woman,
and child and perhaps
pet in every household has
to have a Netflix account.
He says, don't be absurd.
I said, I'm not the one
estimating $600 billion
in revenues.
That's an impossible story.
I'll make a statement--
you might not believe this,
but as you look at
valuations, you try this out.
One in four valuations that
I see, maybe one in three,
from big name
appraises and banks
are impossible valuations,
it just can't happen.
Its a fairytale.
An implausible
valuation can happen,
but you have to have a really
good explanation for it.
I'll give you one example.
A student of mine went
to work for an NFL team,
I won't name the
team, and he sent me
a valuation of the team, I
don't know for what reason.
So I looked at the
evaluation, he's
put in 3% growth and revenue.
It looks pretty
reasonable until you
get to how much money are you
putting back into the business.
And they own their own
stadium and there was nothing
going back into the stadium,
no investment at all.
So I called him and I said,
I looked at your valuation.
How come you're not putting any
money back into the stadium?
Don't you have to maintain it?
He said, that's easy to explain.
Every time we need to get the
stadium refurbished, here's
what we do.
We go to the city
and we threaten them.
With what?
We're moving to Las Vegas.
Are you going to
fix the stadium?
And it works.
It's an implausible story,
but if you can tell me why.
So implausible
stories can happen,
but I'm going to push
you back and if you
can give me a really good
explanation, OK, that's good.
And improbable stories are
stories where your assumptions
are at war with each other.
Let me explain.
When I look at a
valuation, there
are three sides what I
call my valuation triangle.
There's the growth side,
the re-investment side,
and the risk side.
So help me out here.
If I have a company with
high growth on one side,
what should I expect to see when
I look at your reinvestment?
High reinvestment and usually
high risk. high, high, high.
OK.
That makes sense.
Low, low low makes sense.
You have high, low, low,
I'm going to push back.
And again, you can have
a really good explanation
as to why your company has high
growth and low reinvestment.
You're a toll road
company, you've
spent the last 10 years
building your told roads.
Now you're getting the
growth from those roads.
So you get the high
growth, but you
don't have to reinvest because
the reinvestment is all--
so if you're an
infrastructure, I get it now.
My job in valuation is to
push you on these assumptions.
And if you've
thought through it,
you can give me a
good explanation.
But if you say, look, I
didn't even notice that,
then you have the valuation
that's at war with itself.
So I took my Uber story
and I checked it out.
Is it possible?
Is it plausible?
Is it probable?
And guess what,
I'm describing them
as an urban car service
company, which they're already
succeeding at.
I argued that they're
bringing new users in.
I could use my
son as an example,
but then I'm behaving
like my mother-in-law.
So I'll use the
part of the country
where ride-sharing
has its deepest
roots, which is the Bay Area.
Do you know that
by some estimates,
the size of the car
service business
in this part of the
country has tripled
since ride-sharing
companies came in?
You know what that's
telling you, right?
That there are people now
who take Uber who would never
have taken a cab, who might
have driven their own cars
or taken mass transit.
It's making inroads.
So clearly, that part of
the story works, as well.
It's plausible.
The one part of
the story I wasn't
willing to go to
in June of 2014 was
the story of how Uber could
replace your second car.
It's a story that I'm more
willing to buy into today,
that if you live in
the suburbs like I do.
I drive my car to the train
station every morning.
It's a three-minute drive,
I'm too lazy to walk.
I park it there all day, I
come back in the evening,
I get back in the car, I drive
it home-- six minutes a day.
Weekends I go crazy, like
25 minutes on a weekend.
Collectively, I keep a
car, I pay insurance.
It's insane.
But if I lived in the
suburbs 10 years ago,
my answer would have been,
what other choice do I have?
It's not like I can
call a car service.
Uber is in my town now.
In fact, in the last
few months, I've
been noticing a billboard that
you can see from your train
as you're going through and
it's like every station.
The billboard says, did you
drive to the station today?
And right below it
says, take Uber.
The message is not to me,
I'm too old to change.
But if you are you're 35,
you move to the suburbs,
instead of buying that second
car, you might take Uber.
This is really
good news for Uber,
it's really bad news for whom?
Automotive cars.
We talk a lot about
the disruptors.
The more exciting thing is
what happens to the disrupted?
And there is, in
fact, a price that's
going to be paid
by those companies.
So that's basically your
check on your story.
Now, I'm going to take
a little tangent here.
Let's suppose you're
tired of working
at whatever you're doing.
You quit and you become
a movie producer.
You move to LA.
You hang out at the Bel
Air, Beverly Hills Hilton,
something by the pool.
And I'm going to come
and pitch a story to you.
And as I pitch this
story, you tell me
whether this story
sounds good to you.
It's about a 19-year-old
who drops out of Stanford.
Who does that?
What's their acceptance
rate, like minus 3%?
You got into one of the
most selective schools
in the country and you drop out?
To make it interesting, let's
make the 19-year-old a woman.
Usually it's a male
geek dropping out
and starting a tech company.
This is a 19-year-old woman
who drops out of Stanford
and starts a business--
but not a tech business,
but a blood testing business.
This is something we all have
experience with in our lives,
right?
We hate the way it's structured
right now with the labs that
take forever to run your tests
and charge you $1,500 to take
two buckets of your blood
and feed it to Dracula,
I don't know what.
So she's created
a business where
she needs only two drops of
your blood in a nanotainer.
That sounds pretty
fancy to begin with.
And 32 tests are going
to be run in 45 minutes
and emailed to you and
it will cost you $50.
Do you want this
story to be true?
I do.
These are what I call
runaway stories, stories
that sound so good you're
afraid to ask the question.
You know, the question
that's going to show
that the story doesn't work.
I wish I had made up this
story because it's not
a made-up story.
The 19-year-old who
dropped out of Stanford
was called Elizabeth Holmes.
The company she
created was Theranos.
And in the middle of
2015, venture capitalists
had priced Theranos--
again, that word comes out--
at $9 billion.
Some of the biggest
names were on that list.
And it's not just the
VCs who got excited.
It was the Cleveland
Clinic, Walgreens.
If you'd asked me in
the middle of 2015, what
do you think about
Theranos, my reaction,
there must be some
substance here,
you have all these big names.
But let me ask you a question.
You're investing in a
blood testing company.
What's the first
question you're going
to ask before you put your
money into the company?
Does it work, right?
And you'd assume
that somebody in here
would have asked that question.
But that turned
out to be not true.
In October of 2015, a "Wall
Street Journal" reporter
decided to ask the question.
And this is a
question, the answers
are actually out there
in the public domain
because you have to
file with the FDA.
He went to the FDA
and said, have they
been approved for 32 tests?
The FDA said, no.
They've been approved
for one of the 32.
He said, why?
Because the other 31, the
results are too noisy.
Noisy blood tests--
it's not a feature you
want in a blood test, right?
Maybe you have leukemia,
maybe you don't.
But don't worry about it, we'll
get back to you later, right?
It's not exactly something
you go looking for.
And of course, the story
unraveled after that.
And the final
pieces of the story
are playing out with
Elizabeth Holmes being banned
from the blood testing
business for the next two years
and Theranos kind of unfolding.
Runaway stories
are stories where
you want the story to be
true so much that you're
afraid to ask the question
because you're afraid what
the answer might be.
I would love to
tell you that if I'd
been an investor in Theranos, I
would have asked that question.
But I don't know.
Can you imagine
being in that room
with Elizabeth Holmes saying
do your blood tests work?
You'd have felt like the
hunter who shot Bambi's mother.
Have you ever felt--
I felt badly for that
guy in the movie.
Somebody shot that-- you have
no idea what I'm talking about,
right?
This is what happens when
you don't watch enough Disney
movies.
Go watch "Bambi."
So you're afraid that the answer
is going to ruin the story
and you don't ever
ask the question.
I mean, you'd be amazed at how
many business stories take off
and keep going
because people don't
want to ask that question.
Let me do one other tangent.
Sometimes I look at banking
valuations just for fun,
just to see
inconsistencies pop up.
And this is the valuation
of Tesla, another one
of my favorite companies.
This is a valuation where
the analyst had projected out
growth for Tesla where the
number of cars that Tesla would
produce would go from 25,000
in the most recent 12 months--
this was in 2013--
to 1.1 million in 10 years.
Is that possible?
Sure.
Is it plausible?
Yeah, I can tell you really--
because let's face it,
this is a big business.
So I was OK with that
part of the story.
He then projected on margins
of about 7%, again plausible.
So up to now, we're
on plausible story.
Now, what's the capacity of that
Fremont Plant that Tesla has,
150,000, maybe 250,000 cars?
So I went looking for the
third piece of the puzzle,
are you putting in money
to build more plants?
And in this
particular valuation,
it looked like the analyst
was putting nothing back
into new plants.
In fact, I called the analyst
and I pushed him on it
and he admitted finally that
it had slipped his mind.
I made a suggestion to him.
I said, you know what?
The only way you're going
to be able to get away
with this is you need to
watch "Willy Wonka's Chocolate
Factory."
Have you ever seen that
movie, the old version?
I was a very strange
younger person,
now I'm a very
strange older person.
I remember coming out of that
movie with a big question.
The question was,
Willy Wonka chocolates
are all over the world, but
there's only one factory--
six floors,
inefficiently laid out
with chocolate rivers
running through it and stuff.
And I said, how do they
produce all these chocolates
from this one factory?
And the answer, of
course, is in the movie.
It was the Oompa-Loompas.
Remember them, magical
creatures that dance around
and chocolates come flying out?
I said, here's what
you need to do.
Put out a press
release that Tesla's
fired all of its regular
workers in its Fremont plant
and replaced them with
them Oompa-Loompas.
I call these
Oompa-Loompa valuations,
where you have this growth
and nothing set aside
to create the growth.
It's not going to happen.
So I have my story, I'm going
to convert it into numbers.
So let's start at the top.
I describe Uber as an
urban car service company.
The total market that
I used for my valuation
was the urban car service
market, which is $100 billion
in June of 2014.
I assumed that Uber would pull
in new users into that market.
So here's what I did.
Instead of letting
that market grow
at 2%, which is what it had
been growing going into,
I let it grow at 6%.
I assume that Uber will have
in my story local networking
benefits.
The market share I
gave Uber reflected
that part of the story.
It was a 10% market share, huge
relative to the typical car
service company then
but not a 40% or 50%
market share, which would
come about if you have
global networking benefits.
I assumed they'd be able
to maintain that 80-20 mix.
You're getting 20%
for doing nothing,
your margins are going to
be immense in steady state.
I gave them an operating
margin of 40% in steady state.
And finally, I also assumed that
they would never buy the cars,
they would never
hire the drivers,
which means that they can
grow relatively easily.
So the way I reflected that is
for every dollar they invested,
they got $5 of revenues.
To give you a contrast,
for a typical US
company, every dollar you
invest brings $2 in revenues.
I gave them $5.
Every part of my story
has become a number.
If I take those numbers,
the valuation does itself.
So when you look at
the actual spreadsheet,
it looks like a
spreadsheet, but if you
point to a number in
the spreadsheet and say,
why is Uber making
what it is in year 10,
my answer is never going to be,
because I used a 10% revenue
growth for the first five
years and 7% thereafter.
Its going to be because they're
an urban car service company
with local networking benefits.
Every number in
this valuation will
reflect a part of my story.
And if you read
through the numbers,
we come up with a value.
The value that I came up
with for Uber in June of 2014
was $6 billion.
What is the story that
attracted my attention?
The "Wall Street
Journal" story that
said they were priced
at $71 billion, right?
So 15 minutes after I
post this on my blog,
I get a call from a "Wall
Street Journal" reporter.
She must have been just hanging
out looking for this post.
She said, I've noticed the
valuation you put up of Uber
and you came up with $6 billion.
I said, yes.
she said, you do know
that venture capitalists
have priced it at $17 billion?
I said, yes.
She said, how do you
explain the $17 billion?
I said, I don't have to.
I didn't pay it.
I've never felt the urge
to go around explaining
what other people do.
So all you can do a valuation is
have your story and your value.
It's not my job to
sell you on that value.
I'm not a salesperson, I'm not
an equity research analyst.
I'm not asking you to
sell short on Uber,
I'm not saying don't buy Uber.
I'm saying I wouldn't buy Uber.
And I'm entitled
to make my choices.
So my story has
become a valuation.
I did the same
thing with Ferrari
and here's how my exclusive
club story rolled out.
Because it's an
exclusive club, I
had to give them low revenue
growth, only 4% a year.
Could they grow faster?
Absolutely.
But I can't let them
grow faster in my story.
The bad news is revenue
growth is going to stay low.
The good news is I'm
going to continue
to give them these hefty
margins, 18% margins.
And I'm going to give
them a low cost to capital
because they're
selling to people
who are so rich
that they don't feel
the effects of the economy.
The value that I came
up with for Ferrari
was 6.3 billion euros.
It actually went public
at about 7.5 billion,
it danced around six billion.
It's kind of settled in now.
But this was my story
playing out as a valuation.
Last piece and then we'll
kind of open to questions.
As I said, you
finish a valuation,
you feel pretty good
about your valuation
because it's your
story of value.
And as I said, the
best thing to do
is actually put
it in places where
people who don't agree
with you will read it.
And I got incredibly
lucky with my Uber post
because it got picked up in
four very different places.
The first was a site called 538.
Are you familiar with 538?
It's where numbers
geeks go to hang out
because they apply statistics
and numbers to everything.
It's like money
ball and everything.
The second place it got
picked up was the Forbes blog.
Who reads the Forbes blog?
People who are geriatric
investors who are basically old
time value investors.
The third place it got
picked up was Tech Crunch.
You know who reads Tech Crunch.
And finally, the final
place it got picked up
was this blog called
the Ride-Sharing Guy.
It's a guy who actually writes
for Uber and Lyft drivers.
There are actually
enough of them
that he can write a
blog just for them.
I got four very different sets
of reactions to my blog post.
The people in 538 nitpicked.
They said, why did you use
a 10% chance of failure?
Why not a 9.96%?
This is how numbers geeks think.
So I said, why don't you
take the spreadsheet--
because I put the spreadsheet--
and change the 10% to 9.97%
and see what happens.
Five minutes later,
I get an email,
now I see why you used 10%.
So all that nitpicking
with really no big picture.
The Forbes blog people loved it.
They said, this is
the way they should
be valuing companies, those
crazy Silicon Valley people.
I ignored the Forbes blog.
No point going there and getting
patted on the back saying,
this is amazing.
The Tech Crunch people
absolutely hated it.
They said, how dare you value
one of ours with your d.c.f.
We don't do that
in Silicon Valley.
I got this wave of abuse.
And in addition to
the wave of abuse,
I got some things about this
business I wouldn't have known.
I'm not a tech person, I don't
want to be a tech person.
I'm not a ride-sharing expert.
Remember, I hadn't even
heard of ride-sharing
until June of 2014.
So there were things
about the business
that I would never have known
if I hadn't read those posts.
And finally, from
the Ride-Sharing Guy,
I had some very interesting
things about the 80-20 mix.
They said, this is unusual.
Uber doesn't get to keep 20%
because they kick it back.
They pay us $1,500
to switch from Lyft.
And I would never
have found this
out by talking to Uber's
top management, right?
Because they want to
preserve the illusion
for the investors of its 20%.
In fact, that's what they
said even in the most
recent announcement.
They said, we're
still keeping 20%.
Then how the heck are you losing
$4 billion on a $6 billion
revenue?
The numbers don't gel, right?
And it all came to
fruition while I
was sitting waiting
for a flight to Munich
and I get an email
from Bill Gurley.
I knew who he was.
And the email says, I
read your post on Uber
and I did not like it and
I've written my own post
to counter your post, a blog
post to blog post warfare, very
new age.
He said, I've said some
mean things about you.
I just want to let you know.
I close the email.
I have an hour and a
half left for my flight,
so guess where I go next.
I go Above the Crowd,
which is Bill's blog,
and right there on
the top, it says,
"Damodaran Misses by a Mile."
Get it, Uber driving,
misses by a mile.
And he took issue with
every part of my story.
He said, Uber is not just
a car service company,
it's a logistics company.
Words have consequences, right?
Because all of a sudden,
what have you done?
You've expanded your business
to be car service, it's moving,
it's delivery.
He said, it's not just urban,
it's going to be everywhere.
He gave examples of
suburban services
that they were going to offer.
And he talked
about how they were
going to connect with airlines
and credit card companies
so that when you flew to Jakarta
on United, before they drag you
off the plane you'd get a
little Uber thing at the bottom
where you could click
the Uber and say,
when I land in Jakarta,
I get-- so basically, you
want to connect with
airlines and have your credit
card already on there
so your local networking
benefits become global benefits.
I was fascinated by the story.
In fact, right after I read
the story, I took his story
and put it into numbers.
And it's easy to do.
The $100 billion
becomes a $300 billion
total market if you make
it a logistics market.
The 10% market share
becomes a 40% market
share, the $6 billion value
becomes a $53 billion value.
And then I said, you know what?
Those ride-sharing drivers
told me that 20% is fake,
so I replaced the 20%
with 10% because if that's
the true margin, I
should be putting it in.
And that reduced the value
to about $29 billion.
You're saying, does this
mean any number goes?
No.
That's not what I
would take out of this.
But your story drives
your valuations.
If you're a start-up
entrepreneur,
the way you describe
your company
can make a huge difference
in what people walk out
of the room willing to pay.
So in fact, in December
of 2014, I basically
took this in a blog post-- and
you're welcome to visit this--
and I let people pick
what they thought
about Uber, what kind of company
is it, what kind of networking
benefits.
And at the end of the
blog, I essentially
put a list of values ranging
from less than $1 billion
to over $90 billion,
depending on your story.
And with young companies, that
should always be the case.
You'll have vast
disagreements among people
because of your story.
And in fact, it's
what, two and a half,
three years later with
Uber and you're still
getting a big set
of disagreements
about what the stories are.
There are obviously people who
think it's worth $100 billion
and there are people that
think it's worth nothing.
And this is what makes it so
fascinating, a story in motion.
So as you go through this
process, one final point.
You finish the story, don't
rest too long because the world
changes around you.
There are macro
shifts happening.
The French election tomorrow
could change your story
about not just every
French company,
but about every global company.
You have macro stuff going on,
you have micro stuff going on.
Every time a company
reports earnings
or announces an acquisition,
it's changing its story
and your job, in a sense, is to
bring it into your valuation.
And your stories can break, they
can shift, or they can change.
Broken stories are stories where
your story just blows apart.
An example would be Aereo.
Remember the company
that said they'd
come up with a way of streaming
things to your device?
You could watch cable
channels on your device
without paying cable fees.
Sounds too good
to be true, right?
And it turned out
that in June of 2014,
the Supreme Court found
that what they were doing
was illegal.
Overnight, the
company essentially
went from being a billion
dollar company to nothing.
That's a story break.
A story shift isn't the same
story, but it can be small.
I've told the same story about
Apple for the last six years,
which is it's the
most incredible cash
machine in history that
derives almost all of its value
from the smartphone business.
And that business is
maturing with margins
that are going to come
under pressure over time.
That's the same
story I told in 2012.
My valuation for Apple
hasn't shifted very much,
but the price goes up and down.
And that's part of investing.
And you can have story changes,
where a company convinces you
that they can do stuff you
never thought they could do.
My valuation for Facebook
has gone from $30 per share
when they went public
to almost $90 per share
because every time
they show me they
could do things I didn't
think they could do,
I have to revisit my
story and change it.
It makes investing
in valuation a lot
more fun if you think
about these valuations
not as spreadsheets and
numbers, but as stories
that evolve over time.
And if you're an
entrepreneur, your job
is to nurture that story and
make it bigger over time.
And if you're an
investor, it's to be
skeptical about that
story and push back.
And if you're an
outsider, to just observe
what's happening in
the stories and attach
a number to those stories.
That's it.
If there are any questions you
have, I'd be glad to answer.
[APPLAUSE]
AUDIENCE: I have a question
about the online advertising
business.
Is in the top 10
worst businesses?
ASWATH DAMODARAN: No.
No, it's not.
It's actually-- you know
it's a profitable business.
The only thing is there are
only two giants in the room
sucking up all the profits--
one is you, the
other is Facebook.
For the rest of the world,
it's become a bad business.
And you're responsible
for-- and that's
your job is to make it
a good business for you
and a bad business for
the rest of the world.
And you've succeeded beyond
your wildest imaginations.
And I think that's what the--
last year if you look at
the growth in this business,
I think 60% of the growth came
from just Facebook and Google.
So it is a profitable business,
but it's a very skewed profit.
The two companies at the top
get almost all of the profits,
the rest don't even get the
droppings off the table.
They're like Twitter, they
basically have revenues
but they can't show profits.
AUDIENCE: What
about the partners
that we have in the ecosystem--
the agencies, the marketers?
Where do you see
them moving as you
said the industry
seems to consolidate
around Google and Facebook?
ASWATH DAMODARAN: I think
they're more commoditized.
They're not going to make
the margins that they do.
They will be profitable,
but you're not
going to let them become too
profitable because if they
make excess profits, you
know what your job is, right?
It's to mop it up and take it
back into the parent company.
So you're like a
parent spaceship
that essentially is watching
all these other little ships.
You look too prosperous, we're
going to-- so again, there's
nothing amoral.
That's the nature of business
is if you're creating the value,
you want to claim that value.
So I think your
ecosystem will survive,
but there will never be
the prosperous mother ship
that you have as a company
because that's what's
creating all those revenues.
AUDIENCE: Measurement it's
a big part of that business,
so teaching brands that online
advertising is valuable,
how do we do a better job of
using the kinds of narratives
that you talked about today?
ASWATH DAMODARAN: I think
that ultimately, it's
the richness of the data
that lets you convince them.
Because right now
you can show people
that they're clicking on--
I think it's easier for you
than it is for Facebook,
for instance, because you have
a search engine that people
go through.
It's much more
direct to say, this
is how you landed on
a site is through us.
I think that
increasingly, you're
going to start seeing
people ask questions about,
oh, people are clicking
on it but are they
actually buying stuff on it?
And as the data
gets richer, you'll
be able to answer the question.
And sometimes you might
not like the answers
you have to give your--
so it's not always
going to be good news.
So you will have to
learn from what works
and what doesn't to kind
of adapt, modify, which
you probably already are doing.
AUDIENCE: My question
is in doing number
crunching or forming
the narrative,
I guess in these
two examples it felt
like the background was
assuming competent companies
and management.
ASWATH DAMODARAN: Oh, I've
told some horror stories, too.
AUDIENCE: OK.
ASWATH DAMODARAN: So read
my story about Valeant.
AUDIENCE: Yeah.
So how do you
account for Uber has
a misogynist toxic culture
or United's assaulting
their passenger?
How do you account
for lack of conversion
that a company just
can't achieve their--
ASWATH DAMODARAN: That's
actually a very good point.
Uber has this combination
of being aggressive--
they've always been an
aggressive company that's
broken every rule in the book
and they've succeeded with it.
But in a sense, it's also
their biggest weakness.
In fact, the best way
to see this play out
is I have a story
about Lyft in the book.
And if you think
about Lyft, I describe
Lyft like you know how in
bike racing if you're a racer,
you actually want to hang
out behind the lead racer
because he or she picks
up the wind resistance?
Lyft is like the rider
who hangs out behind Uber.
So Uber is the one who
does the wind resistance,
goes after the regulators.
Lyft says, we're the good
guys, we're the good guys,
we're the good guys.
It's actually an interesting
different story, right?
It's a much less
ambitious story.
It's a story where you keep
your head down and say,
we're the good guys.
And they're going to do things
very conspicuously to show
that they're the good guys.
You saw that in the
last few weeks, right?
You're the bad guys,
we're the good guys.
It's actually interesting,
but the good guys don't always
win in these stories.
That's, I think, the
other thing is sometimes
this aggressive toxic
culture might actually
be what ends up winning.
So unlike novels, where you
can make the good guys win,
sometimes the bad guys
win in these stories
and it becomes part of
the value of the business.
So in that sense, justice
doesn't always prevail
and morality doesn't
always win out.
It is investing, right?
But I do tell stories about--
I mean, I don't enjoy them
as much-- about companies
that are horror stories.
I mean, I've been telling
the story about Valeant
for the last two years
of a company that
fell from grace, right?
It's a reverse Cinderella story.
It starts off with this--
you start off in the castle, you
end up cleaning the chimneys.
And I think it's fascinating
sometimes watching
horror stories
unfold because you
can see the behavioral and
the psychological issues that
play into these valuations.
SPEAKER 1: So one
of the questions
was regarding a company
which in your blog posts
you call the "Field
of Dreams" company.
The question is,
growing revenues,
the earnings are maybe
shown, not shown,
but the cash flows are there.
And a lot of that
is still driven
by changes in working capital.
So for those of you who don't
know, I'm talking about Amazon.
The question is, how do you
look at a company like that
and what do you think about it?
ASWATH DAMODARAN: You know I
call it the "Field of Dreams"
company, right?
Seen "Field of Dreams?"
Kevin Costner builds
this baseball field
in the middle of
nowhere and people
ask him, what are you, crazy?
Why are you building a baseball
field in the middle of nowhere?
And remember what he said, if
I build it, they will come.
That to me is--
when I think about Amazon,
that is the message
that Jeff Bezos has been
sending right from day one.
If you get a chance,
go check out the letter
that Jeff wrote
about Amazon in 1997.
You know where I found it?
I found it in Google search,
so you can find it, too.
It's actually an
incredible letter
because it lays out what he
was going to do at Amazon.
He said, at Amazon we're
going to go for revenues first
and then after we've
built the revenues,
they will come, the profits.
That's the story
told in '97 and he's
told the same
story for 20 years.
And he's acted consistently
with that story.
You know what I mean
by acted consistently?
How many people here
have Amazon Prime?
What do you pay for it?
$99.
Do you know what it costs Amazon
to service every Prime member?
About $400.
That's crazy, why
would you do that?
If you build it, they will come.
What is he building
with Amazon Prime?
He's building this
block of consumers
who are addicted
to Amazon, for lack
of a better word, Who don't even
know what a retail store looks
like anymore.
And one of these days,
he's coming for you.
So don't be surprised
if a third nine pops up
after the first two nines and
you have nothing you can do,
because where are
you going to go?
Everything else will be
out of business by then.
So the conspiratorial
view about Amazon
is he's building a business
where ultimately, he's
going to get you.
And that explains the
$700, $800, $900 per share.
The problem there is
it is a business where
keeping newcomers out, new
ways of doing business,
is going to be tough to do.
So the challenge here is
what if that doesn't happen?
Well, you could end
up growing revenues
and never being able
to deliver the profits.
So it's, again, a
fascinating case study of how
if you can tell a
consistent story.
Because people often say,
markets are short-term.
You heard that probably
in Silicon Valley.
What short-term market would
let a company go for 20 years
without making a profit and keep
pushing up their market cap?
To me Amazon is the
perfect counter-example
of if you can tell
a consistent story,
markets will cut you a
heck of a lot of slack.
You know why they don't
do it for most companies?
Because the story keeps
changing every year.
The top management is incapable
of telling the same story
over time and then the market
says, we don't trust you.
So the other lesson that I
think you get out of Amazon
is if you're
building a business,
you're telling a story, don't
keep swinging like a weather
vane to whatever works.
You have to have a
consistent story,
you have to act consistently
with that story.
And you'll be surprised
at how much slack you
get cut because of that.
SPEAKER 1: Professor, before
we get to a specific question,
there's one question
that we generally
ask of all the guests,
and this is mostly
not only for this
audience, but also
for your audience on YouTube.
You've written this fantastic
book, in addition to others.
What are some books
that you have found
useful that are generally
underappreciated?
ASWATH DAMODARAN:
Generally underappreciated.
I thought you would ask me what
my favorite book was because I
was going to revealed
my number crunching
roots and you that my
favorite book is "Moneyball."
That tells you where I--
and I think it's--
but I think in terms of
underappreciated books,
I think that I learn a
lot more about investing
in valuation from
non-business books
than I do from business books.
It, again, goes to
the storytelling.
I need to build my
storytelling side.
I don't know whether
you've ever read,
there's a book written
by an insider at Pixar.
It's a book I absolutely
love because it
taught me things
about storytelling
that I did not know, things--
because let's face it, if I can
tell a story like "Toy Story,"
I'm going to be able to sell
incredible businesses, right?
So I read diverse things.
I read fairy tales, I read--
I mean, I love
serial killer books
because they always end badly.
But I think in a
sense, I get my stuff
from all kinds of
different places.
AUDIENCE: So there
are some companies
that need external
capital at the beginning,
like Tesla, right?
For those companies,
they're actually
more valuable if they are priced
higher because the capital will
be very low, right?
If they are priced
at $2 trillion,
again, issue the
stocks very cheaply
and they get any
money they want.
And it also applies to real
state investment trusts.
How do you put that
in your valuation?
ASWATH DAMODARAN: OK.
The first thing to remember
is you don't set the price,
the market does.
So if you can get them to
give you a high pricing,
it does make your life easier.
I mean, you hear this word
cash burn thrown around Silicon
Valley all the time, right?
Cash burn basically means
you have negative cash flows
up front because you need
that cash flow to grow.
And you have cash burn, you need
capital to cover the cash flow.
You can't survive as a company.
And if you're priced
high, the advantage
is you can raise that capital
at a very advantageous price.
So here is, in fact,
what it plays out as.
For these companies, there's
actually an incentive
to tell really,
really big stories
up front, right, because big
stories get the big prices.
The pricing allows you
then to cover the capital.
There will be a
letdown at some point
because people are going to
say, well, that story never
was going to work.
And then you get all kinds
of disappointment kicking in.
I might be hitting
too close to home,
but anybody ever
hear of Juicera?
I've been reading the
story about Juicera
and I said, what kind of story
would you need to tell me
for me to invest in it?
How many people would pay
$400 for a juicer that's--
I mean, it's a
very small market.
So if you were
telling that story
and I was assuming a market of
50 million Americans buying,
it's a story that doesn't fly.
But if you could push the story
bigger, you'd push pricing up.
It allows you to raise capital
to cover your cash burn needs.
So that's something to remember.
I don't think that's
Elon Musk's rationale.
I think he just likes
telling really big stories
and making them
bigger over time.
But I think for some start-ups,
I think part of this is a game.
If you can push your pricing
up, it actually makes it easier.
It greases the skids
for you while you have
those early years of cash burn.
SPEAKER 1: Don't hit
me for asking this,
I'm just the messenger here.
How do you decide when
there was something
wrong with your estimate
of value and the price
to value divergence stays
on for an extended period?
What are some examples
that you can share with us?
Could you talk a little
bit about your investing
in Valeant and
Twitter and so on.
And again, I'm
just the messenger.
ASWATH DAMODARAN: As I
said, one of the things
I find that gets in the
way of good investing
is I tell people the
three words that you
need to be able to say openly
in investing is, I was wrong.
Because once you say that, it
frees you from your own story.
Because as long as you're
not willing to say that,
you're going to find
ways to kind of take
your old story that it's
not wrong, this part of it--
it's somebody else's fault.
I have absolutely no qualms
about accepting the
fact that I'm wrong
and I'm horribly wrong
sometimes and it's not my fault.
That's what allows me
to get away with it.
It's not my fault
in the sense there
are things happening around
that I really can't control.
So when I'm wrong, I have to
look at what portion of it
was my fault and what portion
of it is out of my control.
With Valle, here's
what happened.
I bought Valle and
Brazil went to hell
in a handbasket in the
year after I bought Valle.
You say, why didn't
he predict that?
If I had been able
to predict it,
there were a lot easier
ways to make money
than to go out and buy--
I could have sold short
in Brazilian bonds.
It was out of mind control.
I call this the karmic
moment in investing.
You've heard of karma, right?
Basically, karma means
there are some things that
are going to happen, nothing
that you and I can do
can change that.
You've got to accept that
on Valle I was wrong,
but there's nothing I
could have done about it.
With Valeant I was wrong
and it was partly my fault.
And here's what I
missed in Valeant.
For those of you not
familiar with Valeant,
Valeant built its reputation
as an uncommon pharmaceutical
company by going out and
acquiring other drug companies
and doing something that
is morally and ethically
questionable.
They would take underpriced
drugs and reprice them.
You know what that means, right?
So you're a company
which is at a--
let's say you're heart
drug that's been around,
it's been patented
for eight years.
They're charging $50 a dose.
It serves only
like 7,000 people.
And Valeant said, those
people will pay $5,000.
They need it to live.
They raised prices.
They did incredibly
well for a period.
But that story was a story that
worked only as long as they
stayed under the radar, right?
Because this is
not exactly a story
you're going to tell openly--
we buy other companies,
we take their drugs,
we increase the price
50% or 500% or 5000%.
So when Valeant
came apart, it was
because they got too ambitious.
They got too big.
They bought Salix, an
$18 billion company.
When they tried to raise
the price of the drugs,
people noticed.
And the minute that happened,
the whole company unraveled.
It dropped from
$200 down to $32.
And I bought it at
$32 saying, look,
there's still enough
value in the company.
You know what I missed
is this company did so
much damage to its reputation.
We talk about corporate
sustainability.
It taught me a lesson about
why corporate sustainability
has a place in Valeant.
They had done so much
damage to their reputation
that nobody trusted them.
Because I assumed
that they would become
an old fashioned drug company.
But to become an old
fashioned drug company,
what do you have to do?
You have to build
an R&D department,
you've got to hire scientists.
Let me ask you a question.
You're a scientist, I'm Valeant.
I come and say, do you
want a job at Valeant?
What's your reaction?
I've heard about you guys,
I'm not coming there.
So they're having trouble
building their business.
They try to sell a
portion of the business.
I'm Valeant, I try to sell a
portion of my business to you.
What's your reaction?
You guys are liars.
I don't trust anything you do.
So what I missed in
the case of Valeant
is the damage that they had
done to their reputation that
makes it almost impossible for
them to be a going concern.
That damage cost me, what, 60%
of my investment in Valeant.
But it's a lesson that
I can use when I think
about other damaged companies.
So would I buy United
after the billion dollars?
Maybe.
Here's why.
It's a damaged company,
but it's in a business
where they're all damaged.
There but for the grace
of God goes Delta, right?
Don't assume that Delta would
not have dragged you off.
Maybe they'd have dragged you
off a little more gently, OK?
This is a business-- and that's
why I bought Volkswagen after
the--
because I looked at
Volkswagen and said, hey,
do you think only
Volkswagen does this stuff?
They all do it.
You've knocked down the
value of Volkswagen 24%.
So it's a game
I've played before.
But in the case
of Valeant, I got
this warning sign of
sometimes a company
can step across the line so
much that coming back over
is going to be
really tough to do.
And the other thing
is a mistake will
cost you a lot less if you don't
have half your money invested
in the mistake.
So this is actually a pushback
against what you sometimes
hear from value investors which
is don't spread their bets,
buy four great companies.
I have never
believed that advice.
That's hubris to think
that somehow you've
got these four winners forever.
So to me, the reason I keep
any investment I make at 10%
or below my portfolio is because
I know I can make mistakes
and I have to be aware of that.
SPEAKER 1: What does your
typical positions always
look like?
ASWATH DAMODARAN: I would
say on entry about 5%.
If it does well, if will get
to 10%; if it does badly,
it takes care of itself, it
goes away from my portfolio.
So Valeant is no longer
5% of my portfolio.
So it's really the stocks that
do well that I have to nurture.
And in fact, with
Apple this will
played out over a 15-year period
because I bought Apple in 1998
and I bought it as a
charitable contribution.
Because I loved Apple so much.
It looked like it was
going out of business
and this was going to be
my final contribution,
look how much I loved you.
Here, take the $14.
It turned out to be the
best investment I ever made.
Sometimes shows you that
your best investments don't
come from all your
intrinsic value stuff,
it comes from your
charitable contribution.
The problem with
Apple is did so well
that it kept pushing
into that 10%.
I left about half
the profits I'd
have made on Apple on the table
because I had to keep selling.
And I have no
regrets for doing it
because that's what I need
to do to be disciplined.
And one of the things
I've discovered is if I--
the way I do this
is I automate it.
Do you know what I
mean by automate it?
I have limit sells on
every single investment
in my portfolio that I have
put in before it happens.
Because if I wait for it
to happen and then I say,
should I sell it now, I find
delusional ways of saying,
this time is
different, this stock
is going to keep going up.
So sometimes lots
of time you've got
to realize that you
can't trust yourself.
You essentially have
to automate the process
to take it out of your hands.
SPEAKER 1: So we were talking
about your limit order
on Apple before,
and I think it would
be nice for the
audience to maybe share
some of that conversation.
But I found it very interesting.
So you had an estimate
of intrinsic value
and once it hit, the limit
order executed for Apple.
My question to you
was, if the price then
goes below that price, are
you going to buy again?
In other words, how do
you think or quantify
the margin of safety and
how do you differentiate
buying and selling?
ASWATH DAMODARAN: When I
bought Apple, I got lucky.
I bought Apple at $94, I
put a limit sell at $140,
and it executed so Apple
is out of my portfolio.
I've bought Apple
four times and I've
sold Apple four times
in the last six years.
Why?
Because my value stayed
stable, but here's
what happens to Apple.
A new iPhone comes out, revenues
jump 8%, people start dancing
in the streets.
It's a growth company again.
They push up the price
too much and then
four quarters later,
their revenues
drop because the iPhone
is aging and people
are convinced that this is
the end, they sell Apple off.
So it's almost like
your taking advantage
of a manic depressive, which
is what the market is-- manic,
I sell to it, and it's
depressed, I buy from it.
My rule of thumb,
though, in investing
is I want to buy when I feel
that a stock is undervalued.
And when I value a stock, I
come up with a point estimate.
But that's, again,
hubris, right?
Because I made assumptions.
The assumptions were
revenues will grow 7%.
But if you push me, I'd
say, well, you know what?
They probably can grow 5% to 9%.
So over the last few
years, I've taken
to using Monte Carlo
simulations in my valuation,
partly because it forces me to
be honest about how uncertain I
am and then it forces me to be
specific about how uncertain I
am.
And I get a
distribution of value,
that becomes my basis
for deciding when to buy.
So I'm not going to buy
Apple when it drops to $139.
My value is $140.
It dropping to $139,
I'm still with--
if you look at
this distribution,
I'm so close to
my expected value.
So by having a distribution,
I can look up a trigger point
and say--
and I have to set the trigger.
It has to be at
least 80% undervalue
to kick in, which would be
about $124 to $122 for Apple.
That becomes the
basis that I think
about both buying and selling
is in terms of distributions,
not in terms of point estimates.
SPEAKER 1: So do we
have one live question
from the audience?
Yeah.
AUDIENCE: So this
actually echoes--
I guess you mentioned a
Monte Carlo simulation.
I actually did a
Monte Carlo simulation
for my PhD and
part of my feeling
is just that all of
the assimilation--
simulations, number
crunching, storytelling--
all of this is assumptions
that goes into it, right?
And it echoes the uncertainty,
the prediction part
you're talking about.
At the end of the
day, how do I know
I made the right assumption?
ASWATH DAMODARAN: The
word you used was know.
You never know.
And that's something
that-- and that's
I said one of the
biggest problems
that number crunchers have is
a psychological barrier you've
got to overcome, which is we're
so used at the end of a math
problem to checking
the answer and saying,
I know I got it right.
Look, I can check it.
That's why accounting is
so much more comfortable
to do than valuation, right?
Balance sheets have to balance.
It balanced, I'm done.
The problem in valuation, you
get done with a valuation,
and you look at it and say,
how do I know I'm right?
I'll tell you the
answer, you don't.
And you have to be OK with it.
There is no confirmation
mechanism that I can offer you.
That's why I used
the word faith.
What's the essence of faith?
Why do you go to church every
week or temple every week?
It's because you have
faith that God exists.
You say, prove it to me.
I can prove it.
The same thing
applies in investing.
If you ask me, prove to
me that valuation works.
I don't have proof,
I have faith.
And I can't pass
that faith onto you.
So when I teach my
valuation class,
I tell people, at
the end of this class
you have to decide for yourself
whether this works for you.
I can teach you how
to value a company,
but I can't give you faith.
That's got to come from within.
Maybe you will develop
faith, maybe you will not.
And if you don't develop faith,
it's not the end of the world.
You can buy ETFs and index funds
and you'll be perfectly happy.
And here is my
definition of faith,
and it's going to sound morbid.
I ask people who are
active investors,
let's say you get to the age of
85, you're on your deathbed--
I told you it was
a morbid thought--
and I come to you
with some statistics.
I say, look, over
the last 60 years,
you've been doing valuation
and picking stocks
and you made 8.13% a year.
This is cruel and unusual to
somebody on their deathbed.
And then I say, you
know what, if you
had put your money in
ETFs and index funds
over the last 60 years,
you would have made 8.22%.
So you've spent 60
years of your life
doing two hours of
research every night
and you've essentially made
less money than you could have
by just putting your money--
would you be OK with it?
And if your answer
is no, I tell people
don't do active investing.
I'd be OK with it.
You know why?
Because I enjoy
the process so much
that even if at the end
of the game you told me,
you're not going to make any
money off this, I would say,
I'm OK.
I've had lots of fun doing it.
And that's, to me, part of
the reason the storytelling
works is if I were just
crunching through spreadsheets,
I would drive myself crazy.
Because when you
do spreadsheets,
you want affirmation--
I did all this hard
work, I tortured myself.
I need to be rewarded.
And the market says, no, you
don't need to be rewarded.
I'm going to take away 20%.
And your neighbor,
who picks stock
based on astrological
signs, is making millions.
You say, this is so unfair.
It's the way the world is.
So unfortunately, there
is no way to know.
But that's the part about faith
is it might come, it might not.
But it's got to
come from within.
AUDIENCE: And a small
quick follow-up question
is, when we look at
valuation, how do we learn?
For instance, if the
numbers come back
agreeing with my
prediction, does it
mean that I did a good job?
How can I tell which part is
my work, which part is not?
ASWATH DAMODARAN: Here's
what I tell myself.
When I pick a stock and it
goes up, the first thing I say
is, I got lucky.
And then I say, OK, maybe
I did something on the side
because luck is the dominant
paradigm in this business.
There's so much stuff
that's out of your control
that you really
can't do much about.
And it helps you both on
the plus and the minus side.
That's why I can be sanguine
about the stocks that go down
is you can't be selective.
And this is what
behavioral finance
finds, when something
works you want
to claim credit by yourself.
When something doesn't,
what do you do?
You blame the rest of the world.
I mean, when I talk about taking
ownership of your investments,
what I'm talking about
is taking ownership
of both sides of
the investments.
So we need to behave
exactly the same way
when we win as we lose.
And that's really tough to do.
I have to force
myself to try to do it
and it doesn't
come easily to me.
SPEAKER 1: You've written
about Facebook, about Amazon,
about Apple.
Traditional value
investing has generally
sort of put tech in a
certain light because
of the risk of, I guess,
innovation disruption
and whatnot.
Do you think over time
that has changed and does
value investing in
technology work well?
ASWATH DAMODARAN:
It should change.
And I think part
of the problem is
we use the word tech
to capture this very
diverse set of companies now.
In the 1980s, if you
said tech, I'd have said,
young, high growth, risky.
Today when you say tech,
you're talking about 22%
of the market.
And you're talking about
companies that range
the spectrum in life cycle.
Intel is tech, but so is
Facebook and so is Snap.
But what do they
share in common?
One is a company that's I mean,
not quite the walking dead,
but if you think
about Yahoo, so you
can have walking dead tech
companies which are essentially
looking towards the exit and
you can have companies growing.
So a couple of years
ago, I actually
took every tech company in the
US and I broke it down by age.
It took the founding year and
I then looked at the metrics
by age.
And tech companies age
in what I call dog years.
Do you know what I
mean by dog years?
A 20-year-old tech company
is like a 140-year-old
manufacturing company.
Because the old man--
if you look at GM
and how long GM and Ford took
to go from start-up to mature
company, it took them 60 years.
They stayed at that cash
cow status for about 30
and then they went into
this long-term decline.
A tech company, you look at it,
the growth that took 60 years,
you do in eight.
That's the good news.
The bad news is you
don't get much of time
to enjoy yourself as a cash cow.
And then when you
start declining,
the drop is precipitous.
So if you think
about life cycles,
the life cycle is a
much steeper lifestyle.
So in tech companies,
I think we need
to stop talking tech
as a collective space
and think about some of the
best bargains in this market
are in the old tech space.
I'm talking the
Microsofts, the Intels.
These are cash cows.
Can be disrupted?
Sure.
So can GM, so can Ford, so can
Coca-Cola, so can McDonald's.
What makes us think that just
because you have a consumer
product company, I
can't disrupt you?
Disruption is part
of this process.
So to me, ignoring tech
because you feel it's too risky
means that you're at
least 75 years old.
Because we have
frames of references
that come from the
1980s and the '90s
that people are still
carrying through.
I was happy when Warren
Buffett finally bought Apple
because it's a small
step, but for a long time
his view was, I don't
buy tech companies.
In fact, his view
was, I don't buy
anything I don't understand.
And that basically
means 80% the world
is going to go
outside the domain
if that's your definition of not
being able to invest in things.
So I think we need to
start breaking tech
into old tech, middle
aged tech, and young tech.
SPEAKER 1: This is
a little bit more
into accounting because you've
written a lot about accounting.
ASWATH DAMODARAN: I say very
nasty things about accounting,
so hopefully I don't have
to say it [INAUDIBLE].
SPEAKER 1: Well,
they still invite you
to events and to give talks,
so I'm hoping all is well.
But you've written about
reinvestment, growth and return
on capital, and how
these are connected
and you talked about that
in your talk as well.
The question is
about definitions.
When you think about
return on capital,
capital can be defined as equity
plus debt minus excess cash.
Some people define capital
as tangible capital
that is used in
operating the business.
What really drives compounding?
Is it the tangible
capital and returns
on tangible capital or is it
how you define it and sort of I
guess what I'm asking is what is
the difference between the two
approaches and how do
you make sense of that?
ASWATH DAMODARAN:
The first thing
is to stay away from the
accounting definition
from all of these things.
And let me explain what I
think about as reinvestment.
You want to grow as a company.
The question I want to
ask you is, what do you
have to spend money on to grow?
When I ask that of a
manufacturing company--
what do you have to spend money
on, new factories, new plant,
new equipment--
and old time accounting
captures with the capex.
You look at a
pharmaceutical company,
what do you invest in to grow?
R&D.
And what do
accountants do with it?
Screw it up big time, right?
They treat it as an
operating expense.
And if I ask a
company like Google,
what do you have to
reinvest to grow,
you can already see the
accounting definitions are not
going to capture what
you put money in to grow.
You might have to grow by
buying young technologies
because that's what you need
to bring into the space.
So one of the
things we need to do
is stop getting focused on what
does the accountant call capex.
Because that's not
going to capture what
I want to call capex at
a company like Google.
Because that's the only way for
me to be rational in the way
I think about valuing
these companies.
If you're a consulting
company, what do you
have to invest in to grow?
Human capital.
So those recruiting and
training expenses that you have,
some of that at least should
be treated like capex.
So my definition of
capex is not going
to match an accountant's
definition of capex
because my definition of capex
is driven by how quickly do
you want to grow and what
do you need to put money in
to get that growth?
SPEAKER 1: Same
thing about capital,
like tangible capital versus--
ASWATH DAMODARAN: Same thing.
Once you make that definition.
My invested capital at
a company like Google
will require me to
capitalize R&D, right?
Because if you put
money in R&D and I
do what the accountants
do, it will never shop as--
SPEAKER 1: What about goodwill
and non-operating assets
and stuff like that?
ASWATH DAMODARAN: Goodwill
is kind of a useless area.
It's the most dangerous
variable ever created
because it shows up when
you do an acquisitions
and accountants--
it's a plug variable.
SPEAKER 1: So you
would not count it.
ASWATH DAMODARAN:
I wouldn't count it
as part of invested capital,
simply because you could
consistently keep [INAUDIBLE].
Because goodwill captures future
growth, it captures stupidity,
it captures premiums
you're paying.
It captures everything you do
over and above that book value.
So to me goodwill is
a non-asset, right?
SPEAKER 1: OK.
Thank you so much
for humoring us
with our questions and your
valuable time and talk.
[APPLAUSE]
Thank you so much.
