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Don’t pay heed to commodity prophecies, they’re always wrong: Aswath Damodaran

Damodaran said mean reversion works about 90 per cent of the times.

Updated: May 06, 2019, 05.50 PM IST
There is a perception that revenues of cyclical and commodity businesses normally increase during expansions and vice-versa.
A commodity or cyclical business is directly linked to the economy and global factors. If you are planning to time the market considering the outlook given by economists or market experts, think twice.

In an interaction with ETNow, NYU Stern professor Aswath Damodaran said if someone buys cyclical and commodity companies to play the cycle, then she is asking for trouble.

“The history of people predicting commodity price cycles is not a good one. When is the last time you heard an oil price expert actually get a forecast right? I do not know even why we listen to these guys anymore,” he said.

“Buy a good cyclical company for the right reasons. If you are buying an oil company, buy it not because you think oil prices will come back, but because it looks cheap at today’s oil price,” said Damodaran, considered an authority on valuations globally.

Metals and oil majors have delivered mixed returns to investors in last five years. While shares of NMDC, Oil India, JSPL, ONGC and SAIL plunged between 10 per cent and 35 per cent during May 2014-2019, others like Hindustan Zinc, Hindalco, JSW Steel, IOC and HPCL more than doubled investor wealth in the same period.

There is a perception that revenues of cyclical and commodity businesses normally increase during expansions and vice-versa.

The Indian equity market, where the benchmarks recently hit their all-time high levels, is looking expensive to investors from a price-to-earnings perspective. Sensex traded at a P/E of 28.90 times on May 3 against a five-year average of 21.60 times, indicating overvaluation at index levels.

So is it the right time to pick stocks? Damodaran said mean reversion works about 90 per cent of the times, and it is a fancy way of saying when things revert to the way they used to be.

However, he also cautioned that when structural models change, mean reversion stops working. “When you look at the Shiller PE, it looks like it worked really well for that century, which was the 20th century. There are still people out there who feel stocks are overpriced and they used the Shiller PE to back it up,” he said.

“My reacion to them is that the model might have changed and using the Shiller PE or any other historical number as your basis for investing is extremely dangerous. So one thing I had asked people to look at is whether they think the world today is different than it was 20, 40 or 50 years ago. The answer is, ‘absolutely’. If the world is different, there is a danger here to assume that history will repeat itself,” Damodaran said.

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