Episode #155: Aswath Damodaran, New York University, “They [Uber And The Ride Sharing Companies Collectively] Have Disrupted This Business…That’s The Good News, The Bad News Is I Don’t Think They’ve Figured Out A Business Model That Can Convert That Growth Into Profits”
Guest: Aswath Damodaran holds the Kerschner Family Chair in Finance Education and is Professor of Finance at New York University Stern School of Business.
Date Recorded: 5/10/19 | Run-Time: 57:14
Summary: As it is Uber IPO day, Meb and Professor Damodaran start with a discussion about Uber and ride sharing valuations. Next, the two get into Professor Damodaran’s work and his framework for thinking about valuation. He covers the craft of valuation, and how his framework evolves over time. Professor Damodaran then shares details on what he thinks about Amazon and Apple, how he thinks about valuation in the context of each company, what he’s learned, and how his process has changed over time.
Meb then asks Professor Damodaran about his thoughts on dividends and buybacks. Professor Damodaran starts with the corporate finance side of the discussion by describing buybacks and their role in the cash return to shareholders, the impacts buybacks have on corporations and investors, and the psychology behind the thinking about buybacks.
The conversation then shifts to a chat about Professor Damodaran’s work on valuations, and his current take on global valuations and equity risk premiums. He gets into the equity risk premium in the U.S. during 2008 and 2009 and the information that can be gleaned from studying the history of equity risk premiums.
As the conversation winds down, Meb asks professor Damodaran to talk about industries he feels are ripe for disruption. Professor Damodaran responds with some interesting insights into education, publishing, and banking.
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Links from the Episode:
- 0:51 – Welcome and introduction to guest, Aswath Damodaran
- 2:51 – Uber IPO
- 4:32 – Uber’s Coming out Party: Personal Mobility Pioneer or Car Service on Steroids? (Damodaran)
- 5:51 – Contrasting Professor Damodaran’s Uber valuation with that of Lyft
- 7:26 – Narrative and Numbers: The Value of Stories in Business (Damodaran)
- 8:50 – Professor Damodaran’s work and evolving framework for valuation
- 12:59 – Professor Damodaran’s experience and thoughts on Amazon and Apple
- 14:00 – Investing Whiplash: Looking for Closure with Apple and Amazon! (Damodaran)
- 24:12 – Buybacks
- 32:43 – What Professor Damodaran would suggest if he were drafting legislation on buybacks
- 35:42 – Damodaran Online
- 39:51 – Equity risk premiums in 2008 and 2009 and the implications for markets
- 41:03 – International equity valuations
- 44:19 – UK stocks as a current opportunity
- 47:04 – Industries ripe for disruption
- 52:51 – Research Professor Damodaran is interested in right now
- 53:48 – Range: Why Generalists Triumph in a Specialized World (Epstein)
- 55:07 – Most memorable investment
- 56:19 – Connect with Professor Damodaran – Damodaran.com, Musings on Markets
Transcript of Episode 155:
Welcome Message: Welcome to the “Meb Faber Show” where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the Cofounder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
Meb: Welcome podcast listeners. We have a special show for you today. It’s a rare Friday episode and one we’re turning around same day. So we’ll see how this turns out, sounds like it’s gonna be a lot of fun. But it’s Uber IPO day, getting back some of that excitement from the late ’90s, got a bunch of fun IPOs coming out. Today’s guest I’ve been super excited to have him on is Professor of Finance at NYU Stern School Biz He
s been the recipient of a bunch of fellowships awards. He’s written a gazillion publications and academic journals, authored a bunch of books we’ll talk about a couple today. His YouTube channel even has over 100,000 subscribers. Pretty impressive for, quant finance topic. Welcome to the show Aswath Damodaran.
Aswath: I’m glad to be here. Thank you for having me Meb.
Meb: This is gonna be a lot of fun. You know, I’m here in Los Angeles, I assume you’re in New York City. Although you were LA guy at one point, you did some study and teaching at UCLA right down the road, right?
Aswath: I’m actually in La Jolla right now looking out of my window at the ocean. So actually it’s… I was trained living setup, I live in La Jolla, but I teach in New York Mondays and Wednesdays so I commute.
Meb: So that is a smart setup. I think that you got the right idea there, it’s easy living down here, I love La Jolla. Burning question I have before we get started was I understand that you’re a tennis player, and back in the day, you used to trade volleys with Professor Fama now Nobel laureate Fama. But the question is who won? Who had the upper hand in those tennis games back then?
Aswath: Well if you’ve ever seen Gene argue he’s very competitive, and if I did not let him win, he would not have a good day, and I would not have a good day either. So as a research assistant you learn very quickly early in the process that it’s best to keep your professor happy, so I kept him happy.
Meb: I love it. Are you still playing? You still get on the court?
Aswath: Not as often as I’d like to, but I now live in a climate where I can play whenever I want. In New York, it was always more difficult.
Meb: Well you come up to the road to Manhattan Beach, we’ll take you out on a surfboard any one of these days. All right let’s get started. I got a lot to talk about today. Obviously, the big thing in the news, Uber IPOing pretty exciting. You know, I was actually just in Chicago, I didn’t really notice any strike at all, I was still taking Uber’s and Lyft’s just fine. But you know, you’ve been writing about valuation, particularly pertaining to the ride-sharing companies, at least for probably five years now, I think talking about Uber. Give us a broad overview of what’s going on. Uber comes out at a fair price, super undervalued, overvalued, what’s the perspective?
Aswath: I first valued Uber in June of 2014, and got it horribly wrong. And in a sense, as I’ve gone through time, I’ve tried to learn from my mistakes. I think that… here’s what we’ve learned over the last five years, Uber’s changed the way we take car service. I mean, it changed, who uses it, how much it gets used. So you gotta give Uber and the ride-sharing companies collectively the credit for having solved one half of this equation. They’ve disrupted this business, they’ve changed the way we use car service, that’s the good news.
The bad news is I don’t think they’ve figured out a business model that can convert that growth, to profits. Because what’s allowed them to grow so fast, what’s allowed them to scale up so quickly, is exactly what’s getting in the way of them making money. They don’t own the cars, they don’t hire the drivers, like having a bunch of free agents. The drivers are essentially free agents who can switch at any moment. And that’s creating trouble for them in terms of making money, half of the equation.
Meb: So what’s the answer for them? Where do you think there’s some light at the end of the tunnel? I think you said they came out today, what mid-40s, $80 billion-ish valuation. Does that sound reasonable? And if not, how do they grow into it?
Aswath: The value that I gave them is $60 billion, that’s a pretty optimistic value from my perspective because it’s based on the premise that Uber and Lyft are essentially going to become a duopoly. That they’re gonna be able to raise prices and eventually make money, with some side businesses kicking in, whether it’s Uber Eats or Uber Freight, or whatever it is providing the additional oomph. At $80 billion they’re raising the ante, they’ve got to do even more on the side to get to $80 billion.
And I know people have big ambitions about autonomous cars, but I’ll be quite honest, I don’t even know how that business will end up. Because if Uber and Lyft actually own those autonomous cars that’s a very different business, it’s a capital intensive business. It’s not something that either the company has shown the capacity to do yet.
So the end game here might be there might be autonomous cars, but they might be owned by Google, and by Tesla, and Uber and Lyft might be the matchmaker still. And I’m not sure they’re gonna be in a strong position to command a 20% share of the fare if that happens. So I know that a lot of people are, you know, putting the autonomous car story out there, but I don’t think they’ve thought through what that story means in terms of capital investment and profits. So there are pathways through which Uber can get to those stratospheric value levels, but I think they are narrow and incredibly rocky, I think it’s gonna be tough to get there.
Meb: Contrast this a little bit with any differences you see, when you did the Lyft valuation. When you were talking about Lyft, a few months ago when it went public. I’m a very small Lyft shareholder from the Carl Icahn round. I wasn’t as smart as Carl, I think he sold all of his to Soros before the IPO. But contrast it with Lyft, it’s similar but not quite the same business.
Aswath: In fact, Uber versus Lyft is a two… I mean I call these multistory stocks, because in a sense, a story is driving the valuation. And it also provides a contrast between companies that have really big stories versus companies that tell more compact stories. The upside of telling a really big story… which is the Uber story, especially if you go back four years, Uber was going to be all things logistics in all parts of the world, is you get a big pricing because people look at that huge potential market. But the downside is, you now have all these distractions to take care of, you gotta grow in China, you gotta grow freight, and you’re doing this all while you’re trying to develop a business model.
Lyft, I think did the smart thing which is become car service, become U.S focused, and said, “We’ve got to get a business model in place before we get ambitious.” So if you ask me to pick between these two companies as investments, I would take Lyft over Uber right now, especially at today’s prices. Because I think that if this becomes a duopoly, the upside for Lyft is much greater than the upside for Uber given how they’re being priced.
Meb: Well, I think the market reads your blog anyway, and they saw the gravitational force of the professor’s valuation has brought Lyft back down to reality. That’s my takeaway. It’ll be interesting to see particularly, as you mentioned… you wrote a great book on this topic about storytelling and valuations, and we’ll get a little more into that. But it’s funny to hear the bullish case on a lot of these companies, particularly in this point in the cycle where the revenues or the earnings, it may be less about the actual numbers and more about the story that people are telling. And you mentioned how they’re framing it. The bulls are… as a sort of huge transportation mobility business, and that is $2 trillion rather than, you know, a tenth that size for the underlying economics.
Aswath: When I read that part of the prospect my first instinct was, “Hey are they gonna count the footsteps I take to get from my bedroom to… I mean ultimately personal mobility could include those, maybe.” There’s an Uber’s service they are planning to offer which will take me from one room in my house to another. It’s a pretty ambitious target but you can see why they do it.
Meb: Have you had the chance to ride a scooter around So Cal, yet, on Bird, or Lime, or any of these others?
Aswath: No. I value my life too much, and I value other people’s lives to much. And talk about a bad business model, I don’t even understand the [inaudible 00:08:37] business model I think it’s a strange one.
Meb: I’ll give my only comment is you should definitely try it, you find a lonely street somewhere there down in La Jolla. And the problem is it’s a lot of fun, and it’s super cheap. I don’t know how as a business, they’re gonna make any money, but you should try it and put on a helmet. So you’ve been doing this valuation work… so you packed your bags from UCLA, you went to New York world-class city. I love it there, my wife spent some time at NYU. And started teaching a security analysis class, which I think got morphed somewhat into the valuation class you teach today and have been continuously.
Will you maybe talk a little bit about… we only have an hour today so we only have so much time. But talk a little bit about your framework and how you think about valuation. ‘Cuz it’s a little different than what you see from a traditional textbook and finance professor.
Aswath: It is true. The class I was given, the class of security analysis class, think of it as the Ben Graham converted to a class, carried over from the ’50’s to the ’60’s. And even by the mid-’80’s, it was far too rigid of framework. I mean if you did not pay dividends, essentially the argument you should pay for a stock, but even by the mid-80s, I could see it really did not make sense. So one of the reasons I first changed the name of the class from security analysis to evaluation, is this is not just about assessing the price of a stock, this is about valuing businesses, valuing sports front. It’s a much broader issue.
And the second is, I’ve learned as I’ve gone on my framework for value constantly shifts. I describe valuation as a craft, and I tell people look, you know, it’s a craft where you’re never quite gonna master it, you got to leave the door open to change, and to learning. And I constantly learn new things about things I’m doing badly and I need to fix them. I’ll give you an example, two years ago, when I valued Uber, I did the traditional way you do valuation stock with revenues work down to earnings and then cash flows and you value the company.
And I got some pushback from people I admire was that “You know, maybe you’re using a 20th-century framework to value a 21st century company.” And they were talking about the fact that companies today, measure success based on number of users, number of subscribers, number of members. And it seems like an odd framework to think about total revenues when they’re talking about users, members, and subscribers. So about two years ago for the first time in my life, I decided I was gonna value a user, or a rider, in this case, an Uber rider and build that to value from the bottom up.
It was a couple of weeks of work because the frameworks don’t have to be changed, you just have to think about that framework differently. I tell people, you know, you think about discounted cash flow models, you think about Excel spreadsheet, in a very rigid framework. But the essence of value is you’re saying that it comes from cash flows, growth, and risk so you can adapt it to value, user, rider, subscriber.
So I valued Uber from the ground up based on its riders, and then I had this framework, which I could use to value a Netflix subscriber, an Amazon Prime member. I had more fun than anybody should have over the next year, trying this out on different frameworks. And of course, if you just think about the companies that have gone public, Pinterest, and Lyft, and Uber, I mean, you’re talking about companies built on intimidating numbers, 91 million riders, 20 million users. And this framework allows me to seperate user-based companies that could have substantial value from user-based companies that are absolute disasters.
In fact, I describe user-based companies as ranging all the way from [inaudible 00:12:12], that’s become my new threshold for a truly bad business model. To Facebook I mean, let’s face it, in spite of all the criticism on Facebook, it’s managed to convert its users into pure gold in terms of earnings and cash flows. So what it allows me to do is take these companies that talk about users, subscribers, members, and ask the right questions, because that to me is the basis of valuation.
If you can ask the right questions… I don’t care if you can do discounted cash flow valuation, or you can predict the most specific cost of capital. If you can ask the right questions, you’re going to come up with good estimates of value. So that to me is the heart of evaluation is knowing what questions to ask when you look at a company.
Meb: Knowing what questions to ask, I think is important, but certainly a lot of experience will help you there. Maybe kind of walk us through… there’s two other companies you’ve written a lot about over the years and have a very long experience with. One I think you mentioned, you’ve owned numerous times, all the way back to the 1990s. And the two that I’m thinking of are two… I think they were the first two American trillion dollar companies. And I’m thinking of both Amazon and Apple.
So these are very different companies, I would love to hear you talk a little bit about each and how you think about valuation. And if there are different questions or frameworks we use for these two, because despite both being near a trillion, I think they’re both back below totally, totally different companies and histories.
Aswath: Let me start with Amazon. I’m very attached to Amazon because as I described, valuation is a craft. Everything I’ve learned about valuing young companies I learned in the process of trying to value Amazon in the late “90s.” I still remember 97 sitting down to value Amazon opening up books on valuation, including my own looking for guidelines, and discovering very quickly that almost everything in traditional valuation stopped working when I looked at Amazon. Because you are taught to take existing earnings and growth, and nothing there helped me with a company with small revenues and big losses, so I had to kind of craft my way to evaluation.
In fact, one of my books, “Dark Side of Valuation” came out of that experience I had from trying to value Amazon. So I valued Amazon for the first time in ’97, and I’ve pretty much valued them every single year since. So I’ve seen this company evolve, and I’ve seen it go up, I’ve seen it go down. So when I hear other companies using the Amazon model… in fact, Uber, a couple of weeks ago said they were the Amazon of logistics. WeWork claims to be the Amazon of… everybody claims to be the Amazon of something. I look at them and say, “You need to look at the history of Amazon to understand why you can’t just so cavalierly use Amazon as your own model because Amazon’s gone through some tough times.”
I still remember in 2001 when Amazon came very close to the edge of survival, and what impressed me about Amazon was how consistent they stayed with their story about the company even through the bad times. Most companies tell great stories in the good times, but their bad times come, their story changes completely. Amazon stayed consistent, they built themselves up as a company, but it was three steps forward, one step back, three steps forward, one step back, but they stayed consistent.
Here’s how my thinking about Amazon has evolved over time, for much of the last decade, probably 2010 to 2011, I thought about them as an online retail company that basically… that was going to be the end game. They’re gonna dominate retailing and become an incredibly successful retail company. But somewhere in 2011 and 2012, , they almost had a reincarnation, you could see them going back to almost trying to look like a startup. They actually… their margins are improving and then they suddenly started to pull back and start to reinvest huge amounts, and I think they reinvented themselves.
When I value Amazon and I’ve done this for the last six years, I value them essentially as a disruption platform. I tell people look, Amazon is in no particular but they can be in every business. In fact, one of the most interesting surveys I saw looked at the 50 largest companies in the world and asked each of them, “If you were asked, list out five of your biggest potential competitors, who would they be?” And I think 47 out of the 50 listed Amazon as one of their potential competitors.
Companies as divergent as JP Morgan at one end to, of course, the Walmart, the UPS, and the FedEx is the other, all claimed they were worried about Amazon with good reason. Every business is a potential Amazon business and to help them they’ve got an army. And that’s what Amazon Prime is to me, is an army they can turn loose on pretty much any business they want. So last September when I valued Amazon, I valued them as a distribution platform and what that gives them is a potential revenue that can be much larger than any revenues you see for any company out there.
In fact, I gave them revenue of $600 billion plus in year 10, which no company right now has. But given that they’re a disruption platform I think they can get there. I think the key for Amazon is figuring out a way as they get into these different businesses to get the money machine going. And given their history, I think they will. But it is an incredibly optimistic, upbeat story about the company. And the problem was, even with that optimistic upbeat story, the value that I got was about $1,300 per share [inaudible 00:17:37] at $1,900.
So when I look at Amazon stock price, people seem to be taking the very best story you can throw at the company and doubling that story. So I’m not sure it’s that great, I mean, you need to almost have a conspiratorial view of Amazon taking over the world, for that price to kind of come through. And perhaps that’s true maybe that’s what we’re gonna end up doing is maybe everything we do will be through an Amazon, no companies or service. But it’s interesting that you can have a… it’s a great company but it’s a company that I’ve gone in and out of, and it goes back to the point I make because this is a big deal, in old time value investing, you’re told “If you have a great company you should just buy it.” I’ve never bought into that.
I mean, at the right price I would buy an awesome company. GE is in my portfolio, I hate the company, but I love to invest. But Amazon is not in my portfolio right now because I think it’s a great company, but given the price at which it’s trading at right now, I think I’m overreaching. So the Amazon I’ve gone back and forth because my story has shifted so much.
Meb: I think that’s a good illustration of the challenge for a lot of investors disentangling you know, the business that they like versus a stock, and use you said it exactly right. And also, it’s a great illustration of the behavioural challenges of owning a stock. You know, if you go back to the late ’90’s journalists love to say, “If you just put $10,000 into Amazon in 1997 and held it today, you’d be a gazillionaire.”
Well, the problem is also, you know, the Mr. Market showing up in times when the stock has been crazy, you know, overvalued, and there’s times when it’s been down 40, 60, 80% multiple times. And so the challenge of sitting through those periods, I think most people look back on it and they only see the gains. But if you go through in real time and lose 80% of your money multiple times, it’s a really challenging exercise for people.
And I one of our FinTwit members, you know, says, “If you went back and bought $10,000, yes, you’d be a gazillionaire but you’d also be a psychopath, because no one else could have held it for the entire period other than maybe Jeff Bezos.” And one of the big things they also would never took a lot of VC money, which is pretty impressive.
Aswath: And in fact, you know, that’s the point I want to make about Uber versus Amazon, is Amazon was never the cash burning machine that many of these new startups that claim to be Amazon-like have become. It was even in its worst days, there was always an endgame of making money, it was never burning through the cash at the rates at which these companies are going through it. So I think that you know, it’s a company I will continue to watch because I think it evolves and each time it changes I’ve got to change my valuation for it.
Meb: Let’s hop on over now to a company you described as the greatest cash machine in history. Apple, listeners I’ve mentioned this a few times where I think the Apple AirPods are quite possibly the best product I’ve owned in the last five years. I actually own three pairs now and do not feel the least bit of embarrassment about that. Part of that is because I have a 2-year old who consistently steals either the earphones or the case. But we actually just got all of our employees AirPods as well because I love them so much. Talk to me about this magical company that just spits out cash flow left and right. It’s a little bit different, despite being about the same market cap, a little bit different business than Amazon.
Aswath: [Inaudible 00:21:00] with Apple the way I backup that greatest cash machine in history [inaudible 00:21:05] is by pointing out that in the last five years, Apple has returned more than $300 billion in cash, more than any other company in history. And here’s the amazing thing while they’re returning $300 billion in cash, the cash value increases by another hundred billion. That’s about as great a cash machine as you’re ever gonna see. But that cash machine for the last decade has been fueled by… much as I love the iPods, and I love my iWatch, and my [inaudible 00:21:32] I have Apple products all over the house. This is a smartphone company now, it lives and dies on the iPhone, and that’s its plus and that its minus.
The plus is it is an incredibly lucrative product for Apple, the minus is that the smartphone business at least for the last five or six years has matured. You’re not gonna get the 10% growth you had before because people have switched over already. So for the last seven years, probably you know, starting probably 2012 I’ve valued Apple as a mature company, which produces incredible amounts of cash, and I don’t think it’s changed very much. The market with Apple, it seems to have this manic depressive reaction.
Which is every time you have a new iPhone that does better than expected people say “Oh, my God, Apple is back to being a growth company.” Every time they have an iPhone update that doesn’t do that well they’re convinced that Apple has crashed and burned. The truth has always been it’s stayed a mature cash machine for much of the seven years. But you see the price kind of overshoots and undershoots.
And it’s actually very interesting to watch it because I think it illustrates the difference in value and price. I mean I tell people we know what drives value it’s cash flows, it’s growth, and risk. We know what drives it’s prices, demand, and supply which is driven by mood and momentum. And mood and momentum are things you can’t really build into a DCM model, and you should that’s what drives prices.
And if you’re an investor, a true investor, what you’re trying to take advantage of is that mood and momentum can push prices up way too high or way too low. And just with Apple, I’ve bought Apple five times in the last 10 years and sold Apple five times in the last 10 years. The most recent was two weeks ago I sold it for $210. And it wasn’t a timing issue, just the fact that I think that if you look at the intrinsic valuation, you very quickly start to get to a point where you said the cash flow is limited. There isn’t enough growth here to keep pushing the stock up, and if it drops too much, I think cash flows are gonna provide a floor.
So if you’re a true value investor, this is a stock where you’d willing to buy and sell, and buy and sell, will work for you. But you can’t just buy and hold, because the old saying of just buying and forget about it is exactly the wrong kind of advice you look at a company like Apple.
Meb: And it’s tough too when you get to the size that these companies are at there’s been a fair amount of quant research that shows that you know, being the largest market cap often can be a gravitational weight for these companies that they often can underperform just by their sheer size. And that being, of course, the forces of creative destruction, and probably that’s the way that it should be. I think Apple is a great somewhat of a transition to another topic that you’ve written a lot about.
My God, I think the politicians and media cannot consistently get wrong over and over and over again, more than they do. But this is the general topic of investing one-on-one probably not in any grad courses this is college level, first level. But talking about ways that companies use their cash. And Apple is a great case study because they pay out both dividends, and they buy back stock. Talk to us a little bit…. put the professor hat on talk to us about just in general, how should companies think about spending the money they have? And then how should they ever if they want to think about returning that cash as well?
Aswath: I’m gonna start off from the corporate finance side of this equation, because I’m always surprised how many CFOs write to me saying, “Should I invest in a project, or should I buy back stock?” Acting as if buybacks are investment decisions. Buybacks are cash return decisions, you’re deciding how much cash to return. And the principle is a, very simple, one, if you cannot find investments that make your hurdle rate, you’re suppose return the cash back to the owners.
So this notion that when you do a buyback, you’re admitting weakness is a strange one because you’re admitting the truth, which is we don’t have the projects. And my problem with this entire debate is that especially from the political side, where people say, “Well, buybacks are terrible because companies that buy back their stock are not investing.” I say that’s true, but they shouldn’t be investing and those buybacks don’t disappear into a black hole somewhere. They end up in investor pockets and guess what investors do with the cash they invest it in other companies.
So it’s not a question of whether you want investing or buyback, but who you want investing your money. And to me buybacks are a way in which cash leaves companies that shouldn’t be investing for the most part and goes to companies, which should be investing, they need the cash more. So to me, buybacks seem a healthy part of this process. Are there companies out there that shouldn’t be buying back stock that are? Yes, because there’s a lot of me-too-ism in corporate finance where people buyback stock because everybody else is doing it.
So I’m not gonna deny that there are some companies out there that are doing stupid things with buybacks. But I think for the most part, if you look at the companies that do the biggest buybacks, they’re doing it because they just don’t have a use for the cash. And to me, it’s healthier that that cash leaves those companies and goes to investors rather than stay in the company.
I get the contrast of Europe where I think companies are under less pressure to return cash back and you end up with a lot of what I call walking dead companies. These are companies where essentially their business model is dead, but they’ve accumulated these huge amounts of cash which they don’t return to shareholders, which they then put back into these bad businesses. And the end result is you have economies that actually end up growing slower in spite of the investment.
So if you want the economy to be vibrant, to create jobs that have real growth, you should be encouraging buybacks, because those are the cash flows that create the new jobs, the new businesses. So I don’t quite understand this anger towards companies that buy back stock and the view that they’re somehow weak companies. I think that the essence of investing is you want to collect a harvest, and to me the cash flows, you get back from the company are the harvest. And buybacks seem to me most sensible way to return cash than the old fashioned let’s pay a fixed dividend every year, no matter what.
Meb: I think a lot of the struggle is with the branding. I think if we could go back in time… and I’m gonna attribute this to you. So if you didn’t say it correct me. But I think I saw at one point in an interview where you described buybacks as flexible dividends. I think that would probably correct a lot of the media and politician misinformation around the topic. Other than the branding, why do you think this topic is particularly hot right now and why do you think this is so hard for people to grasp? And by the way I say hard, I don’t mean… just you know, I often put my crosshairs on politicians and media, but you and I are both writers so I count ourselves as media too.
But very, very sophisticated investors I talk to on a daily basis, somewhat consistently, I think have misinformed views on this topic. Why do you think this is so hard, and why do you think it’s so emotional of a topic this whole dividend, buybacks, returning cash? It seems like it’d be a very boring topic of accounting.
Aswath: Because I think it’s entangled in the biggest social issues. The reality I think… and you see this both politically and economically is manufacturing in the U.S. has been in a steady decline and no matter what you try to do it, it’s not coming back. And for a lot of people, the dream is, if we could only get the factories running again, we can get workers and then get them decent wages, everything’s going to be okay. And I think that the whole idea of buybacks has somehow become entangled with that long term trend. And I understand it, I understand it emotionally, I understand it from the perspective of, “Hey, that’s what the world used look like, why can’t we go back to it?”
So people think if we can just stop buybacks, we’re gonna get factories opening up all over the Midwest, and you’re gonna get factory workers getting $20 an hour and everything’s gonna be good. And I think as long as you believe that you’re going to argue that maybe you should stop buybacks. The reason they’re in the news is very simple. Last year, the S&P 500 companies alone, returned $800 billion in cash, in the form of buybacks. 65% of the cash returned last year by those companies came in the form of buybacks, and that throws people off. And that’s not just the politicians. Think about the old time value investing books, they are all built around the notion of you invest in stocks to collect a dividend.
So there are many value investors who think that this is a rip-off, that they’re somehow being cheated by buybacks, because if only those buybacks have been paid out as dividends, they’d all be a lot richer today. You know, you can try to talk them rationally through this process, but it’s not a rational response, it’s an emotional one. Which is had my stocks haven’t done well, I’m an old-time dividend investor, this is a conspiracy against me that these companies are buying back stock they should be paying dividends.
So buybacks are being attacked both from one side saying you should be investing your money and the other side from people saying you should be paying that out in dividends. So there are very few defenders been left in this game will step up to the plate and say, you know what, there’s nothing wrong with buybacks. So it’s going to be a tough sell, and I wouldn’t be surprised if the collective push against buyback translates into some kind of legislative action, I think it’s gonna be misplaced. I don’t think it should happen, but there’s gonna be something that happens in buybacks. And it’s gonna happen, I think relatively soon. Because I think that there are very few people you know, who can really defend buybacks, especially against the kind of emotional arguments that are made against it.
Meb: I think Cliff Asness has done a good job. But Cliff has this struggle of being a little too academic about it, and he also doesn’t mince words. But my favourite response to a lot of these things… you know, there’s a politician who said, “We need to ban buybacks.” And there was even a mention of dividends too which I said, “Look, you know, let’s think about unintended consequences. All of a sudden, you’re gonna hand CEOs bags and bags of cash now, and what in the world do you think they’re gonna magically invest in the business? No, they’re gonna pay themselves more and probably empire build, and go acquire bunch of other companies resulting in less jobs, because they’ll end up firing a bunch of the new employees.”
Aswath: Bankers and consultants would secretly want this legislation to be passed, because there’s nothing better for dealmakers than having old companies or aging companies have lots of cash. Because you get them to do acquisitions, you get them to do… I mean you can get them to do strange things because this is the magic bullet you can give them. So the plastic surgeon to the business world will be happy if there is a law that stops these companies from returning cash but those are the brakes.
Meb: You see a lot of the evidence, I mean one I wanted to mention was there was a study that looked at CEO compensation that was linked to EPS and then CEOs that had a lot of people say, “Oh all these CEOs are just trying to push up EPS” and they actually bought back less stock than the CEOs that weren’t tied to it. So I’m gonna put you on the hot seat and I don’t know if you have any answers to this, I don’t really. If you’re a legislator, we put Professor Damodaran in Congress and said, you’re gonna be on a committee to make some suggestions.
I mean my feedback has always been a lot of the… I have sympathy with labour share of the pie. You know, I think buybacks is totally nonsensical target, I think a lot of it has to do with boards. But that’s my opinion. You’re on the hot seat, you’re drafting legislation, what do you think would actually help? Are there any ideas that you think are obvious, or that are at least worth trying that might advance this issue as opposed to targeting buybacks?
Aswath: I think first thing is I’d try to refocus the legislation on the problems rather than symptoms. You’re absolutely right buybacks are a symptom of a different problem. So we want to fix the problem of manufacturing, perhaps we have to think about legislation directed specifically at creating good jobs. It might not be factory jobs, that’s nostalgia. So maybe that… you know, if we can focus legislation on solving problems rather than fixing symptoms, I think we’d be much better off.
That might be too much of a hope though because it’s so much easier to just fix the symptom and okay, now we’ve solved the problem. But no, I would like the legislation to be focused. So let’s talk about the problems you’re absolutely right. When you look at Uber, for instance, one of my concerns is that if 3.9 million Uber riders who barely make a living. If this is the kind of job we’re creating in the sharing economy, then I’m not sure that the sharing economy is going to be great for the rest of what happens in the economy.
So I think we need to talk about creating good jobs, but creating good jobs in the economy we’re in, not the economy we wished we were in. So I think we need to focus legislation on solving problems rather than you know, doing something about the symptom. So I would say let’s refocus on, “Hey you want to talk about good jobs, let’s talk about, you know, the kinds of jobs that are being created and why they’re so low paying, and why people can’t make a living.” And that might give us a much better chance of doing something about the problem than just feel good legislation. Where you tell people “I will fix your problem,” but the problem comes back.
Meb: I’m always a big fan of ideas and concepts that align incentives with where you’re trying to get. I’m hopeful knock on wood we’ve had a couple of guests on the podcast talking about these new opportunities zones which are trying to encourage investment in under-invested areas. You know, everyone is always a little skeptical till it happens. But I’m hopeful that this is gonna be a big push for the next 10 years, but we’ll see hopefully, it’s not just one ginormous real estate tax dodge. But I think it could be potentially good.
I wanna talk about a couple more things, we only have so much time before our time’s up. And one of the things you write a lot about moving from the micro to the more macro is looking at valuations across the board. So not just for the U.S. equity market as a whole but also for foreign countries and sectors. Listeners, we’ll add these to the show notes, but the professor has an amazing website with tons of Excel downloads and publishes some very long white papers each year around this time where he summarizes the global risk premiums and everything involved.
So talk to us a little bit. What does the world look like? Are there any opportunities? Are we in bubbles all across the globe? How’s the U.S. stock market look? And give us a very quick background on the lens because it’s a little different the way you look at some of these markets.
Aswath: The data you see on my website is what I call the result of my week of playing Moneyball. Because the first week of every year I just collect data on every publicly traded company because you know, I’ve become disillusioned with the rules of thumb that people keep throwing at me. Six times EBITDA is cheap, 10 times earnings is cheap you know, you should buy stocks when they trade at less than book value.
So finally, I said why do we keep listening to these people make up rules of thumb and the data should tell us, so let’s actually look at the data. So that’s where this process starts. That said though, I am terrible at macro and market timing. So all I do is describe the world as it is, and then say, look, you know, I could tell you which markets to go into, but you shouldn’t listen to my advice because I wouldn’t even take my own advice. I’m gonna go back to what my competitive edge is, which is maybe perhaps, in looking at individual companies and telling stories.
So what I describe on my website is the state of the world as is, and for the last few years, if you look PE ratios across parts of the world and it’s really not surprising when you see the differences. Russia and Eastern Europe look really cheap, but there’s a good reason they’re really cheap. If nothing else, what I find in the data is when things look cheap, there’s a good reason they’re cheap, for the most part. So what you’re looking for are mismatches, something that doesn’t gel. And that’s tough to find at the market level. Simply because in the market level, you’re less likely to see horrendous mistakes than you are at the micro level.
I do compute a number for the U.S. market at the start of every month, which I call my implied equities, sounds fancy. But what I do is I take stock prices at their existing levels, I project out expected cash flows, and I saw for what rate of return you can expect to make, given what you paid for stocks. That number is the measure of price of risk in the equity market. And if that number falls to a really low number, then you got to worry about stocks being overpriced, that you’re charging too low a premium.
As an example, at the end of ’99, that number was 2%. And you look at 2%, so you’re offering me 2%, more than the risk-free rate for investing in stocks collectively, I’m not taking that. And if you tell me the risk premium is too low, you’re also telling me stock prices are too high. So that’s become the number that I focus on when somebody says there’s a bubble, now stocks are gonna collapse. Is I go back to that number to see if it’s there are red flags going up. So for instance, start at this month that number is about five and a half percent, that five and a half percent is towards the 75th or 80th percentile of what equity risk rates have been for the last 50 years, this is not a low number.
So if you’re gonna make a case about stocks being overpriced, it has to be more than P/E ratios are at 22 or that, you know, markets gone up for 10 years, you need something else in your argument. And what I find lacking in a lot of verbal arguments is people make it at a very surface level. Stocks are expensive because P/E ratios are high. That’s not enough for me, you need something more than P/E ratios are high. So my implied equity risk has become my number each month that I track to see if I should be getting worried about stocks collectively.
Now, obviously, it didn’t save me this last week, you know, but in a sense, you could have weeks like this even in markets, which are healthy because you’re gonna have macro shocks to the system as we’ve learnt since 2008. This is a feature of markets, it’s not bad, because every few months, you’re gonna have a crisis roll through. You gotta learn to live with it or you’re going to be out of stocks permanently.
Meb: So you mentioned 2008. So just for context, what would the readings have been kind of at the market bottom in 2009? Was it screaming?
Aswath: In 2009, it was six and a half percent, that’s the highest its been since 1978. So it hit a high… and that six and a half percent was up from four and a half percent at the start of 2008. So that’s what 2009… it’s the biggest single year of change in equity risk range I’ve computed for U.S. market since 1960 that was a crisis. Since 2009, equity risk premiums have been much higher and more volatile than they were pre-2009.
So I tell people look, to me 2008 was a structural shift, a shock to the system that said if your entire investing philosophy is built around mean diversion you better re-examine it, because you were going to revert to a mean, but I just have no idea what that means. So I’m always wary of any kind of investment strategy that’s built on looking at the U.S. and the 20th century and saying that’s where we’re going back to. Because I’m not sure those mean diversion models will mean much given the shift in the actual equation.
Meb: So as we look across the shores, you know, for someone who’s a student of history, I think that’s pretty profound statement you just made that would probably throw a wrench in a lot of people’s views of the world. But as we look around the rest of the world, does the rest of the equity markets look reasonable, expensive, cheap?
Aswath: I think for a while in 2017 and 2018, you’ve got this two-prong, you know, effective markets. The U.S. markets are doing well but emerging markets were doing badly. And then you started to see in 2009 the recovery in emerging markets as people kind of said, “Okay, you know, maybe the global growth is not gonna be as bad as people thought it was.” But I think that right now if you look across the world, China’s come… you know, the P/E ratios in China have come down but they’re still among the highest in the world. It’s not like Chinese stocks have collapsed even before this recent rally, and drop in the last week. You know, Chinese stocks have never looked cheap on a relative basis, they just look cheaper than they were relative to themselves two or three years ago.
So in a sense, emerging markets I think, have come back a little bit to [inaudible 00:42:09] because for a while there you had the story of, “Hey emerging markets are only not emerging anymore, you can treat them like developed markets,” especially towards 2012 and 13. I think we’ve kind of retracted some of that optimism, but I think emerging markets today are still less risky than they were 20 years ago. So I think the line between developed and emerging markets has become a greyer one.
So it’s not easy to say this market is developed, is the UK, a developed market or an emerging market? On any given day I can’t tell with Brexit kind of hanging over there. So I think it’s become more difficult to decide what a true emerging market looks like because there’s so many shades of grey in this contrast now.
Meb: You know, it’s funny as you do a lot of traveling and I was just over in London and one of our largest funds has a strategy that tries to invest in cheap global countries. And Brexit has pushed UK down to some lower valuations. But it’s so funny, you know, you wrote a book on this, but talking about sentiment and mood. And my God, going to the pub with all my Brit friends was like the most depressing thing on the planet, everyone’s just like so dour more than the Brits would normally be. But they still have a dry humor about it.
But contrast that with, you know, being in the U.S. where people put 80% of their money in U.S. stocks on average, and it’s totally different. We’re sitting here talking about, you know, Uber IPO and $400 billion. And those markets over time haven’t been too terribly different over the past 150 plus years. So it’s just interesting to kind of contrast those two experiences. You travel even more than I do all over the world, and it’s funny to talk to our Americans friends because it’s a very myopic view.
Aswath: I tell my students when they ask… because every person in my class has to pick a company to value and they usually come say, “What company should I pick?” And I tell them to go where it’s darkest. I say go where the uncertainty is greatest, because it’s true, there’s a lot of uncertainty and it’s gonna make your valuation difficult, but your chances of finding misvalued things is much greater in the midst of a crisis.
I’m actually looking at UK stocks now because I think that because people are so down right now with Brexit, that they’re selling off good stuff and bad stuff. I mean, I recently bought EasyJet. I mean, I might live to regret it. But I think that… I look at the company and I look at the plans, it’s already got in place for whatever happens with Brexit, and I think I’m getting a pretty good deal.
So my suggestion to people is when they see a market in crisis, rather than run away, which is what a lot of institutional investors seem to do, is to go in the opposite direction. I know that’s the essence of contrarian investing, but it’s so easy to talk about in the abstract, and so difficult to do in practice. But I think that your chances of finding a misvalued companies is so much greater when you have a big crisis hanging over the market. So I think UK companies might be where you want to look right now for your bargains, because my guess is there are some really good UK companies that have been sold off in the context of this crisis.
Meb: There’s an old story about Templeton during the Depression where he just bought every stock on the stock exchange trading below five bucks and just held them. We actually ran that screen, I think it must have been in 2009 and said, “Is it time to do a Templeton?” And granted a lot of them will go out of business but some have the massive multi-baggers. But I think it’s a good example. I’m guessing and I don’t know this. A lot of your students probably wanna value Tesla or maybe some of the cannabis companies. But you know, looking at some of these stock markets that are either down a bunch like I don’t know, Brazil, etc or countries where no one is literally… like the old Jim Rogers investment biker venture capitalists like Iraq. How many of your students actually do that for the project? Do they really go look in some of these dark corners or under research areas, even of the U.S. market, they often take up the challenge?
Aswath: They do, and then they regret it for a little while in the middle because their task is a lot more difficult than somebody who takes a nice healthy company that makes money. But I think they learn a lot more about investing valuation from doing that. Because I tell people, “Look every company you value is a nice healthy company with a long history of profits and an established business model, of course, you can value the company more easy, but so can everybody else.”
Investing it’s about how easy is it to value… it’s not how easy is it to value the company, but how well you value a company relative to other people value the same company. And my guess is today, for instance, nobody’s valuing Uber, they’ve just said, “The uncertainty is too much I’m not even gonna try.” So I think trying to value a company in the face of uncertainty is a good thing, that’s how you get a payoff for doing valuation.
Meb: I wanna touch on one or two more things we gotta start winding down. You mentioned in a couple of places, you know, three of your big passions are writing, teaching, and investing finance, kind of that broad umbrella. But you’ve also mentioned that there’s three passions or industries that are super ripe for disruption. You’re also at the forefront… you just passed by the way, I think a 10 year blogiversary, so congratulations. I think you started writing in 2008, I may be wrong.
Aswath: Exactly. Yeah. December 2008.
Meb: And I hope and pray that you never change your blog design because it’s the old school blog spot on the Musings on Markets listeners, it’s my favourite blog design out there. But I wanted to hear any kind of thoughts you have on the future, pick any those industries you know, or all three as to kind of your opinion on what the next five, 10 years looks like.
Aswath: Let me start with education because it’s the business I’m in most intimately and you have a 3-year-old you said right?
Meb: Just turned 2.
Aswath: Okay, 2-year-old, in about 16 years, you’re going to feel the need to disrupt the education business when you write out that first tuition check. Because I think… I mean if you think about how this business has been built, it’s amazing how little care is given to the customers. You think about those undergraduate students who walk in through the door on that first day, they’re the low people on a totem pole at a research university. At the top, of course of the tenured faculty, and then you’ve got graduate students, and Ph.D. students, at the very bottom are the undergraduate students.
In any other business, you’d have a line of people outside the door demanding their money back. But for 800 years, since University of Heidelberg, whichever the first university was, universities have gotten away with this. And I think that the barrier to entry is you’ve got to be in that physical university to get a degree. So I think disruption is coming, but it’s gonna be slow. It’s gonna be slow because the parents still want the kids to go through a university, get a degree.
So I’m not under any illusions that overnight, we’re all going to go to a different kind of education model. But I think change is coming, and I can sense it in universities, they’re scared, but they’re also too attached to the existing their business models. These are cash cows and they don’t wanna give up on them. So education certainly needs to change, because now I think about what you get for your money, and I don’t think you get enough value for your money on average. So that’s the first one.
Publishing, I mean, if you look at.. especially textbook publishing, it’s a racket. It’s a racket because you know… one of my books actually is both a trade book and a textbook. My trade book is a hardcover, it’s a solid book, it’s $40. My textbook version of the same book exactly the same book, every word is the same is a paperback and it costs $85 why? Because textbook publishers have been able to use the college textbook market and the fact that it could do new editions as kind of a money machine to sell to U.S students.
That business is being disrupted for a simple reason. I mean, if I want to buy a cheap version of my own book, I can get it on Amazon India it’s the exact same book. And it’s not like the old days where you had to travel to India, I could do it online. So I think publishing is being disrupted simply because online buying has changed the economics of that business.
And financing, investing change is coming as well, and there too the change will be slow, but it’s a lot of stuff that is done in finance, you can look into why are we paying the prices we are? The only reason is we have no other choices. You’ve seen how active money management has been assaulted by index funds and ETFs, and our banks are going to see… you know, you’re gonna see Fintech companies going after your softest parts of your business.
And when I moved to La Jolla, I had to transfer money from a bank on the East Coast to a bank on the west coast, I mean, just from my own account. And I remember being charged $40 for it, and saying $40 for what? For moving money from one account to another? I mean, that’s just a microcosm of the kind of easy money that banks make on things you look at and say that shouldn’t cost that much. That’s exactly the kind of soft part of the business that Fintech is going to go after.
And again, the bank’s know it, but I’m not sure they can do much because it goes back to the Clayton Christensen argument, which is if you have too much to lose from the status quo, you can see change coming, but you don’t embrace it, because you don’t want to give up what you already have. I mean, that’s what Barnes and Noble, had in the late ’90’s. And it’s amazing, I teach in a business school. We talk about disruption and how badly companies have dealt with disruption in different businesses. And I look around me and say, “You know, disruption is coming to the university. And none of us seems to want to do the things that we need to do to deal with this disruption.” It’s easy to talk about what other people should do, but very difficult to do it yourself.
Meb: You know, it’s funny, you mentioned the transfer, I was laughing because I think the most alpha I’ve ever generated in my career as an investment manager was transferring an IRA from one brokerage to another that somehow took like three or four months. And it was during a down period in the market, just randomly because… and I’m like, how is this process in 2019 still take three months? It’s kind of crazy.
But hey, look, I’m hopeful everything’s moving in the right direction. We, chat with a lot of the high fee for all intents and purposes, closet indexing crowd, and I think most of them the approach is, stick your head in the sand, let the cash flows happen for the next 10, 15 years, let them decline and just wait for people to die. I say that, you know, not ironically, in any way. In the research world… one or two more questions we gotta go. In the research world what’s got you most excited today? What are you thinking about as you look out to the horizon? Any topics that are particularly… got your juices flowing is it crypto? Is it valuing art collections? What is it?
Aswath: At this stage in my life, I’m a dabbler, I move from one passion to another and I have the luxury of being able to do it. In fact, the next company I’m gonna value is “Beyond Meet.” I’m just fascinated by how a company can come out of nowhere all for what seems like a product that other people are offering and end up with this multi-billion dollar valuation. So I’m doing it because I’m interested this week, next week, it might be bitcoin again.
So I have the luxury now of doing… just looking at things as they interest me. And I think that in a sense, it does give me an advantage because I dabble, so I’ll go from topic to topic, from business to business. And you know, I tell people… you know, there’s this book by David Epstein. I don’t know whether you’ve had him on, but you should where he talks about foxes and hedgehogs. And hedgehogs are, of course, these experts who know everything about a particular field, and how terrible they’re at forecasting. Foxes know little about lots of different things. So I’d rather be a fox than a hedgehog going forward. So I’m just gonna dabble.
Meb: Speaking of Beyond let’s do a little research here. Have you tried either the Beyond or Impossible burgers?
Aswath: Yes, in fact, one of the things I’ve tried to do whenever I value a company is I try its products first. So I went last week to the grocery store and got Beyond and I got three other competitors, including Impossible. So I’m gonna do a taste test this weekend.
Meb: All right, so I’m not gonna bias you because if you look on my Twitter feed, we did a poll I said, “Which one do you guys prefer?”
Aswath: [Crosstalk 00:54:35].
Meb: I’m not gonna tell you what it is because I don’t wanna bias you. Are you vegetarian or are you an omnivore?
Aswath: No, matter of fact, I’m not… see that’s the thing is I think this is a market where you want to get people who love meat, but fell guilty eating meat, so that’s a subset of the market you’re going after. I don’t love meat, and I’m not guilty even when I eat meat, so I’m not particularly the right person, but I’ll still try it.
Meb: I have a very, very strong opinion on this, but we’ll see how it comes out, I look forward to the article. Last question we ask everyone, you look back on your career, you know, for someone who’s been a student of Fama, it would probably surprise a lot of people that you’re not just buying a bunch of ETFs and mutual funds but you do a fair amount of investing. What’s been your most memorable investment, as you look back on all the various investments? It could be good, it can be bad, but what’s the one that jumps to your brain first?
Aswath: The most memorable is actually an investment I made almost as a charitable contribution, which is when I bought Apple in the late ’90’s, because I felt sorry for the company and felt it was going to go away, and this is going to be my charitable contribution. I bought it at $6, and I sold it 12 years later, for $600. So, I mean it actually is a reminder to me that some of my best investments I make for the wrong reason, some of my worst investments I do all the research, and I do for the right reasons. And luck is so much a part of this process, and to me, that reminds me of that.
Meb: A 100% I think mine, I haven’t mentioned it before you just reminded me of it when I was young, was when Marvel was coming out of bankruptcy. And I was just a comic book guy, I loved their comic books. I said, “Man, it’s three bucks” or whatever it was and say, I don’t think I got 100 bagger, but I think it was a 10 bagger. Professor, where can people find all your writings, what you’re up to, what you’re doing? What’s the best places to keep track of you?
Aswath: The entry point is basically my last name.com. So damodaran.com will put you on my website, but that has a link to my blog. Any company I value, everything I pretty much think about markets, I vomit onto my blog, so basically, it’s there. And I don’t hold anything back simply because nothing I do is that profound that’s worth holding back. So you know, I’m pretty open about putting everything online. So you know, start with the website and you can pretty much find everything I do.
Meb: Very cool Professor Damodaran, thanks for joining us today.
Aswath: Thank you.
Meb: Listeners, we’re gonna put the show notes on the blog mebfaber.com/podcasts. We’ll have all the show links and links to the YouTube channel, and all the websites. You can subscribe to the show on iTunes, Radio Public, Breaker any place good podcasts are sold. Thanks for listening friends and good investing.