Podcast Summary
Understanding Stock Valuation: PE Ratios and Forward Earnings: Expert insights reveal the importance of local knowledge and global expertise for stock valuation. PE ratios and forward earnings are key tools, but require deeper understanding to accurately assess stock value.
Understanding the value of stocks is a fundamental aspect of investing, yet it can be a complex and often misunderstood concept. Principal Asset Management, a real estate manager with a global perspective, emphasizes the importance of local insights and global expertise to identify the best investing opportunities. On the other hand, in the world of finance, even the basics can be worth exploring. In an episode of the Odd Lots podcast, hosts Joe Weisenthal and Tracy Alloway discussed the topic of stock valuation, which is currently a timely and relevant theme in markets. They welcomed a guest considered to be the foremost expert on the subject to help demystify the process. While some may associate investing with figures like Warren Buffett and the concept of putting a number on a stock, many people are unsure of how to actually go about the process. Key tools such as PE ratios and forward earnings are often thrown around, but it's essential to delve deeper into these concepts to truly grasp the value of stocks.
Understanding the difference between stock price and company value: Professor Damodaran emphasized the importance of understanding the foundational concept of valuing a company based on its cash flows, growth, and risk using a simple dividend discount model.
Key takeaway from this discussion with Professor Azwath Damodaran is that while the price and value of a stock may be different concepts, the value of a company is ultimately determined by its cash flows, growth, and risk. Professor Damodaran emphasized the importance of understanding this foundational concept and starting with a simple dividend discount model to analyze the present value of future dividends. He also shared his perspective on the evolution of investing, acknowledging that while buying stocks for dividends may seem outdated to some, it remains a relevant approach based on the fundamental principles of value investing. He emphasized that accountants are not the best resource for valuation, and that everything in valuation is built on tested and proven concepts, not new methods. Overall, Professor Damodaran provided valuable insights into the world of corporate finance and equity valuation, challenging listeners to go back to basics and understand the true value drivers of a company.
Shifting focus from actual dividends to potential dividends: Valuation analysis should now consider potential dividends by estimating a company's cash for accurate assessment of its value, especially for growth firms that don't pay dividends but return cash through stock buybacks
The nature of companies and the market has significantly changed, leading to a shift in the way cash flows are returned to investors. In the past, companies with excess cash flows paid dividends, and investors held stocks for the long term. However, today, many top companies are growth firms that don't pay dividends but instead accumulate cash and return it through stock buybacks. Therefore, instead of focusing solely on actual dividends or buybacks, valuation analysis should consider potential dividends by estimating the cash a company could theoretically pay out after meeting all business needs. This approach allows for a more accurate assessment of a company's value, especially for young growth firms. The overall valuation process remains the same, but the focus has shifted to estimating potential dividends instead of actual ones.
Valuing Uncertain Companies: Embrace the Uncomfortable: Valuing uncertain companies involves making estimates, accepting uncertainty, and shifting approaches based on company's business model
Valuing a company, especially one with little historical data or a novel business model, involves making estimates and living with uncertainty. The process may require assessing probabilities and using statistics, but it's important to recognize that there are factors beyond your control. The absence of comfort in valuing these companies is a normal part of the process. Additionally, the increasing prevalence of business models without clear historical analogs adds complexity to the task of valuation. Companies like Snap, which can be classified as media, tech, camera, or apps companies, present unique challenges as they shift from a top-down approach focusing on overall revenues to a bottom-up approach emphasizing the number of users or subscribers. Ultimately, the best you can do is make your best estimates and accept that you may be wrong.
User-based valuations: Valuing companies by their users: Companies with large user bases can have astronomical values, but investors need clear information on user behavior and revenue distribution for accurate valuation.
The value of a company is increasingly being determined by the number and behavior of its users or subscribers, rather than traditional revenue and cash flow metrics. Companies like Microsoft, Adobe, Uber, Amazon, and Netflix are leading this shift towards user-based valuations, which can result in astronomically high values due to the large number of users they have. However, investors are struggling to obtain the necessary information to accurately value these users, such as renewal rates and revenue distribution. If companies are asking for investment based on their user numbers, it's their responsibility to provide the necessary information for better valuation. Every valuation tells a story, but as an investor, it's important to take ownership of your own story and not solely rely on the narrative pushed by the company.
Understanding Valuation vs Price: Successful investors distinguish between valuation and price, have faith in their valuations, and look for catalysts to bring the market in line with their valuations.
As an investor, it's crucial to distinguish between valuation and price, and understand that valuation is subjective and based on the story of a company, while price is determined by supply and demand. To be successful as an investor, one must have faith in their valuation and the market's eventual correction to that value. If faith is lacking, one should consider being a trader instead, focusing on buying low and selling high without concern for the reasons behind price movements. When looking for undervalued companies, it's essential to identify catalysts that can cause the market to recognize the value, such as management changes, activist investors, or competitive pressures. Without a catalyst, the market may not adjust to the true value, potentially leading to financial loss.
Understanding a company's story behind market value: Value investors should differentiate between companies with changing stories and pure pricing stocks, and focus on fundamentals for long-term investments.
As an investor, understanding the story behind a company's market value is crucial. When there's a significant repricing of a company, it could be due to a change in the company's story, or it could be due to market mood and momentum. For value investors, it's essential to differentiate between companies whose values reflect a different story and pure pricing stocks, where mood and momentum play a significant role. In the case of GE, a company in decline for over a decade, the best hope is that it doesn't become decrepit, but there's no good story that'll allow it to come out of this as a growth company. As an investor, it's important to stay calm and avoid making hasty decisions based on market fluctuations. Instead, focus on the fundamentals and the long-term story of the company.
The importance of effective leadership for a company's success: Strong leadership and effective execution are crucial for a company's success. The fit depends on the company's stage in life. Visionary leaders like Elon Musk are essential for companies with immense potential, but they need trusted COOs to manage execution. For declining companies, liquidator CEOs might be the best fit.
Effective leadership varies depending on a company's stage in life. For a declining company like GE, a "liquidator" CEO like Larry might be the best fit. However, for a company with immense potential like Tesla, a visionary leader like Elon Musk is crucial. Yet, Musk needs a trusted COO to manage the execution and operational side of the business, as Tesla's execution problems pose a significant risk to the company's success. Regarding the stock market, despite some concerns, it's not overvalued as long as earnings growth remains strong, the tax reform package passes, and interest rates stay low. Overall, the conversation highlighted the importance of strong leadership and effective execution for a company's success.
Learning from old finance ideas in a changing economy: Professor Aswath Damodaran discusses the continuity and applicability of old finance ideas in the face of economic changes through insights on Tesla, Bitcoin, Uber, Amazon, and the need for real-life examples like Saudi Aramco. Check out his blog musingsonmarkets.com for more deep dives into various companies.
Learning from this episode of the Odd BOTS podcast is the continuity and applicability of old finance ideas in the face of economic changes. Aswath Damodaran, a finance professor and blogger, shared his insights on various companies like Tesla, Bitcoin, Uber, and Amazon. While the discussion was insightful, there was a desire for more real-life examples, such as Saudi Aramco. Aswath's blog, musingsonmarkets.com, is a great resource for deep dives into various companies and their financials. The upcoming Money Stuff podcast, featuring Matt Levine and Katie Greifeld, is another exciting finance resource to look forward to.