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Stop treating everything marquee investors say as the gospel truth: Aswath Damodaran

‘You have to come up with a way of thinking about markets that is unique to you’

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Last Updated: May 29, 2020, 08.15 PM IST
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Low PE stocks, high dividend yield stocks have underperformed high PE and no dividend paying stocks.
I do not have much faith in accountancy and I think book value has completely lost its meaning, says Professor, Stern School of Business, NYU.

The world can clearly be divided into two parts. The optimists believe that a vaccine would be found and liquidity will ensure that asset prices remain strong and we could be in for a surprise V-shaped recovery as the consumer demand unleashes in the first half of next year. Then there are some realists who would again insist that medical breakthrough is still away. The collateral damage to the economy is very large and since the world has never experienced a lockdown ever even during World War, there is no template which will tell you what is coming next.
I think they are both wrong in a sense. You cannot look at this glass as half full or empty. One of the reasons I am not a market timer is on issues like this. It is sometimes better to let the market decide because we think that the market has this monolith device but it is really a consensus of both optimist and pessimist. Right now in the US, the optimistic side is winning but that does not mean it is over right. Two weeks from now or four weeks from now or six weeks from now, it could shift. What I have learnt in 35 years of investing is you can disagree with markets but you have to respect them. And I respect the market. I am not a market timer. I watch markets and say maybe markets are wrong but I do not have the ammunition to tell you that they are wrong.

I am a stock picker. I am going to go find stocks that I think are good investments no matter what the market is. So my suggestion is do not fight the markets. In fact, one of the things I said last week to an audience was do not project your feelings onto the market. What I meant by that is I have been getting emails from people saying how come the market is so stupid and how come the market is not seeing what I am seeing. The market is seeing what you are seeing and what a million others are seeing that is the market’s job. So do not convince yourself you are right and the rest of the world is wrong because the track record of people who do that is not very good.

You have always maintained that one should not get carried away with what the Fed action. But right now everyone in the financial market is clearly of the view that if you have to choose between fighting the Fed or the fundamentals, do not fight the Fed and that also explains why financial markets have gone higher because the general view is that central bankers will act as a backstop.
One of the problems with narratives without data is you can tell whatever story you want. I call these fairy tales but just that the story does not hold out. Treasury rates in the US dropped in the first two weeks of this crisis, which is February 14 to February 28. Now almost all of the drop in treasury rates happened in those two weeks. The Fed first started acting in March. So by the time the Fed started acting, markets already marked down the treasury rates.

If your argument is that the Fed somehow came in and bailed the market out, I do not see that in the data because the rate drop happened before the Fed came in. I do believe that the Fed has played its cards very well in this crisis. What I mean by that is the power of the Fed comes from the perception that it has power and it has got to preserve that perception. So some time in the first or second week of March, the Fed announced with the lot of fanfare that they might provide a backstop in the corporate bond market. It is something that the Fed usually does not do. It is a huge market. They announced that there will be a backstop. How much money they have actually spent being a backstop? Nothing because what it did though was create enough faith in the system that private lenders who are willing to lend to Boeing and the airlines and what has been unique about this crisis is that the private risk-taking market, whether it is equity or debt, has not dried up unlike 2008. I think the Fed playing its cards right contributed to allowing capital to flow in.

One reason the market is so upbeat is one of the biggest worries at the very bottom of the market in the middle of March was that you were afraid for not just small companies but of big oil companies, airlines and Boeing and that fear has faded into the background and it is part of the reason why these companies have been able to raise capital.

Singapore Airline a week and a half ago raised equity in billions of dollars and that is not something you should be able to do in a crisis. But that I think is one factor where the Fed can have an effect. But the Fed has got to have a light touch. If it tries to be heavy handed and this is true for any central bank, the perception will change very quickly.

Your latest blog piece on what is growth investing and what is value investing has got a lot of people thinking again. In this new normal, your blog and your work seems to be indicating that value investing is dead. That is a very powerful statement coming from someone who is the dean of valuations. Do you think that typical old school value investing is over?
I think this is unique in global history. We shut the global economy down completely for multiple weeks and for a period between March and early April, the entire global economy was shut down and that has never happened before. The 2008 crisis was primarily a developed market crisis because emerging markets were relatively unaffected. Go back in time and take every crisis; you never had a crisis when the entire global economy has been shut down and because of that all of the numbers that you are seeing are going to be numbers that are almost unusable.

Unemployment is one issue. You look out of your window and what do you see? Everybody around you is not working either; how can unemployment not go up? Consumer confidence of course is going to collapse. It is not just consumer confidence collapsing. You are feeling people's psyche under siege because you are stuck at home. So one of the things about this crisis that makes it different is you get no indicators by looking at macroeconomic numbers because usually when you know that it is a crisis is when companies start to layoff people as they get less confident and that did happen here. Everybody had to lay off people right at the start of the crisis. So I think that this crisis is unique in the sense that it is a global economic shutdown and none of us know how the global economy is going to behave when we start the engine back up again. 2020 is going to be an awful year and there is no way around how it can not be.

You know retail stores are forced to shut down for an entire quarter. Your revenues are not going to reflect that but the real question is what will happen after the crisis passes? Now what will happen not just in 2021 but all the way through 2025. I have been valuing the market off and on for the last 10 weeks and there are two big numbers I need to forecast to value in the market; how much will 2020 earnings be affected and the answer is not a very huge amount. But the second important question is how much of that loss will come back in the next four years and how much of their loss will be recovered because you are not going to get 100% of the recovery back. Why? Because if you skip a hair cut during these 12 months, you do not take three haircuts after you come out of the crisis to make up. So there are some services that will forever lose revenue. So there is going to be some lost revenue that is not coming back. It is the second question we should be focussing on. Think about markets; not just about 2020 but what will happen in the aftermath and I think that requires we take our eyes off the crisis and think about what is coming after.

The point you have raised in your blog post is in this new normal, value investing is dead. You actually have some data in your blog post which seems to be suggesting that if one really looks at the comeback stocks in the post-Covid world, they are not value or high dividend yielding stocks. Now that is a very powerful statement or an indication coming from someone who is known as dean of valuations?
In my view, value investing and growth investing has become a very lazy categorisation. Value investors say we buy stocks but the basis for all time value investing has become this; I am going to buy stocks that trade at low PE ratios or low multiples and book value and call it value investing. You ask growth investors what they mean by growth investing. They point to growth and earnings; high growth in earnings, high growth in revenues and we jump onto the bandwagon. I think they both miss the boat with that definition.

Can I value a growth company? Absolutely. Can I find a growth company to be undervalued? Why not. I had held Tesla and I hold Facebook right now in my portfolio and neither of those stocks would fit a value investors’ classic definition but value investors are still stuck in the 20th century. They think that book value actually means something. I do not have much faith in accountancy but I think book value has completely lost its meaning. What is the book value of a Google capture? Your biggest assets are off the books. So I think the problem with value investing and growth investing is not the focus on value and growth but they do not really focus on either. They focus on these metrics and these are shortcuts and those metrics are lazy and part of the reason both groups of investors have lost out in X funds. Remember what you are doing is mechanical. Remember, machines are going to be much better at doing mechanical things than you are.

One of the reasons I wrote about value versus growth in the last blog post I had on the crisis is value is being losing out to growth for the last decade or so. What I mean by that is the old and value stocks; low PE stocks, high dividend yield stocks have underperformed high PE and no dividend paying stocks. And for 10 years, value investors have told us to just wait; wait for a crisis and then you are going to see value investing is going to come back on. You have your chance now. It is a crisis. So I said okay; let me go and look at the numbers. Maybe this is when the payoff to buying low PE high dividend stocks is and you are going to see the pay off. It is in the crisis and what I have discovered in this crisis at least it is for the worse. The stocks that are being hurt the most on low PE, high dividend yield stocks. So if you are a value investor, your last piece of ammunition is being taken away and this is the wakeup call for all-time value investing. I do not know what will be because they are stuck in metrics that really do not work anymore.

When some of the marquee investors like Buffett, Sam Zell, Howard Marks, Stanley Druckenmiller all of them are clearly indicating and suggesting that markets have run up ahead of themselves; which is that markets are here and valuations are here and there is a disconnect and valuations are unlikely to expand given the shape of the economy. Now these are experienced guys who understand the power of leverage, who understand how to differentiate between value and growth and who also understand what is a right time to take risk. Why do you think some of the smartest Wall Street investors who have been successful and are masters of their craft are indicating and suggesting that markets should come down.
Let us take Warren Buffett. He is not just a great value investor. People in value investing treat him like a God. Every word that comes out of his mouth they hang on to and I did listen to Warren Buffett talk because he gives his own line Berkshire Hathaway talk, which he usually gives at Woodstock in Omaha where people show up. As I watched him talk, my sense was this is a 90-year-old. He looks like a 90-year-old and he talks like a 90-year-old and there is nothing wrong. You have to pay heed to age but he looked uncertain. He looked unclear about what was going on and who can blame him. I looked at the substance of what he was saying and there was very little he said. People might not fly as much anymore really. This is the insight I am going to get by listening to Warren Buffett; therefore, I am going to sell airlines. I do not make that leaf. I do not see how people not flying as much means that all airlines are going to be bad investments. It might actually now make the airline business a bad business if some of these airlines dropped off in this game.

It is not that these investors are not successful investors. It is not that they have nothing of wisdom to offer to us. It is we who have to stop treating everything they say as gospel and start questioning. I taught people in my class; do not think anything because that is really how you become a better investor. You have to watch out for yourself, you have to come up with a way of thinking about markets that is unique to you. You cannot pair with somebody else. So I do not care how great an investor’s history has been or how wise they are. I would listen to them but it is my job to create my own perspective.

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