In an exclusive conversation with a guest who is in a league of his own, Aswath Damodaran, a valuation guru and a professor at the Stern Business School in New York, talks about what investors should do in the stock market at current valuations. An expert on valuations, Aswath says while he would consider anything at the right price, he feels the upcoming Paytm IPO has real potential, as a true disruptor in financial services and payment processing.
AB: Markets have been at consistent records, we have seen no dent in momentum, primarily supported by the Fed's easy money policy, of course. How does a retail investor approach the market? Many are worried they have missed the boat? How do they find the right time to enter the market?
AD: Why separate a retail investor from a professional investor? Implicit in that distinction is the assumption that professional investors have some insight into what's coming. I've had 40 years of dealing with MF and hedge fund managers and they're just as ignorant. I think what we've learnt in this market is that professional investors are chasing retail investors not the other way around. I think if you're an investor, professional or retail, you have to make the decision as to why you're in this game. Are you trying to preserve and grow your wealth over time or are you trying to get rich quickly? Are you an investor or trader? And I'm not saying the latter in some negative way -- a lot of people are in the market because they want to get rich quickly and this is a market that seems to be rewarding those people, rewarding those traders. As an investor, you need to decide what game you want to play. And don't be disheartened, be patient, your turn will come.
AB: You're the biggest authority on valuations… do the old principles of value investing still apply? What metrics do we apply when looking for opportunities to invest? Should retail investors look for growth or other metrics in this market?
AD: If by old principles you mean buying low PE stocks, that's what I call lazy value investing and that hasn't worked in a long time. Using shortcuts that give you undervalued companies. People have held on to the belief long after it stopped working. It deserves to die and die quickly. The alternative is to do the hard work and assess where the value comes from. (It) Can come from growth, cash flows generated, you can be a value investor and buy the young money-losing company at the right price, which is better than an old, mature company at the wrong price. Revisit what value actually means. Doesn't mean you deliver earnings today, be capable of delivering earnings in the future.
AB: You created quite a stir with your comments on the Zomato IPO pricing. This year we also have Nykaa, PolicyBazaar, Ola all coming up with their IPOs -- companies with $3-4 billion valuations. Is your scepticism to do with all tech companies or was that specifically for Zomato?
AD: I don't extrapolate beyond a company I am evaluating. Can't say all tech companies are overvalued. Will look at them one by one. Zomato -- will never say never, at the right price will invest in any company. Due diligence requires you to look at an individual stock, not make the judgement on a group. IPOs are likely to be overpriced right now, but one of them may make it to my radar as a fairly valued or undervalued company.
AB: Should investors wait to invest post listing when euphoria dies down and valuations are more reasonable?
AD: In every market, when a company goes public first, traders rule the game. Mood and momentum drive day-to-day price changes. I've discovered mood and momentum can shift in a moment. When Facebook went public, I said it's overvalued, and three months later it had halved in value and it's been in and out of my portfolio since. Same with Uber, at the time it went public, it looked overvalued to me, four months later it looked cheap. So I would suggest if you really like a young growth company that's going public, whether it's Paytm or any other company, value the company, you don't have to jump in during the IPO. But keep re-valuing the company because one day it will make it back on your radar as undervalued. Never give up on a company, think of it as a work in progress, you're valuing the company, the market is pricing the company and one day you'll get it at the right price.
AB: New tech companies are chipping away at the older listed behemoths in sectors like finance, auto… do you see that as a growing trend as these tech majors contribute more and more to market cap as a percentage of GDP?
AD: Yes, in some sectors. There are two things I look for: How big the market is -- financial services and automobiles are both huge markets. And the other thing I look for is the existing status quo. One indicator that a business will be disrupted is when nobody is happy -- customers, companies, regulators, with the status quo. That's the status in financial services, the status quo hasn't worked in automobiles for 40-50 years. When no one is happy, you're open to disruption. I'm also waiting to see it in airlines, people haven't been able to figure out how to run an airline in 50 years. You'll see disruption in businesses where the existing way of doing things is no longer working.
AB: You mentioned airlines… is that a huge contrarian play? Most people are so sceptical about entering the segment. One new low-cost airline that's betting on demand in India... a few remaining listed players and a sector that continues to see a lot of turbulence.
AD: Sector has two strikes against it... it's very capital intensive and also has a rigid business model -- a lot of fixed costs that stay on the books for a long time. In fact, 2020 was a reminder of how handicapped airlines are when they are in a crisis. One thing a disruptive airline will have to think about is how to change the business structure. Airlines are running like they did 20, 30, or 50 years ago. Deregulation in the US was in 1977, 44 years later airlines still haven't figured out how to change the way of running this business. I'm not saying it's easy but the time is right for someone to come in and say the old way is not working. The new way to structure it does not need to have fixed cost and rigidity that's there in the old model. Might take 2-3 tries before getting there, but the existing way has run its course, where the end game is losing money and burning through cash.
AB: You talked about markets being driven by the Fed's policy, and I know you have very pointed thoughts on that, so do you see any scope for a correction anytime soon? Whether gradual or a sharp fall? Do you see markets aligning with economic reality? Or are we past that possibility and now it's all going to be smooth sailing or at the most, consolidation?
AD: Not sure about the economic reality, as I'm not a macro-economist, but one thing that troubles me about markets is mixed signals that I am getting. The bond market is signalling slow growth and low inflation, while stock markets are signalling fast growth and perhaps high inflation -- one is likely to be wrong. My guess is the bond markets will have to do some correction. Whether quickly and a big correction, or whether gradually, we don't know. I'd rather have a 15-20% correction and get it over with than have an extended period of 5-6-7 years where stocks do absolutely nothing, which is much more damaging for investors' morale. I expect a Barmitzvah moment where people wake up and say these things don't match up. But don't know if that will be overnight or overtime.
AB: Do you think the Fed will change its stance earlier than anticipated? Do you see them raising rates sooner than expected?
AD: It may be out of their hands. If rates start rising, the Fed will have to run to make it look like they … reminds me of a story of a rooster called Chanticleer, a rooster that is the strutting master of the barnyard that he lives in, revered by the other farm animals because he is the one who causes the sun to rise every morning with his crowing (or so they think). In the story, Chanticleer's hubris leads him to abandon his post one morning, and when the sun comes up anyway, the rooster loses his exalted standing… Fed is like Chanticleer, it has to make it look like the sun is coming up, rates are going up because they chose to make it go up. If any good sense, Fed will try and raise rates before they go up. My guess is the Fed is going to be chasing markets on this one, rather than the other way around.
AB: Equities have been the asset class of choice, especially for retail investors and with spare savings over the last year and a half... will equities continue to dominate as other asset classes seem less attractive… even crypto… you call it millennial gold… has been very volatile?
AD: Among financial assets, equities are running against no competition. Usually, when not investing in stocks, invest in bonds, but yields are close to zero. The question is equities are nothing. Relatively, stocks are looking really good, relative to history they look awful! Right now in the US, equities are priced at a 6% expected return on an annual basis in the long term. If I'd offered investors 6% in the 80s or 90s, they would have laughed me out of the room. Right now, among financial asset classes equities look good. And because returns are low in asset classes, people are looking to make money elsewhere like crypto or NFT… imagine paying $75,000 for a video clip… you can see what desperation drives you to do when you don't think you can make money in financial assets you'll always look elsewhere. Until 30-40 years ago, it was only gold. Bitcoin has become a trading instrument of choice for young investors, who think they can make more money on investing in alternative investments than financial assets and who can blame them.
Also read: August sees a reversal of fortune for IPOs
AB: On equities.. would you suggest Index Investing or stock picking? What's the ideal strategy in a market like this?
AD: Go back to living your life. Put money in an index fund and go back to living your life whether you're a doctor or lawyer. For 95% of investors, that's the most sensible strategy. Only 5% are active investors or traders. Find your own investment philosophy that best fits you. Don't follow me, Warren Buffet or anyone else. If you want to be an active investor, find your pathway, your strengths and weaknesses, what you're comfortable doing. Investors trade with a philosophy so don't try and be someone else. So many people read books and are trying to be Warren Buffett, even he doesn't always deliver returns following these books anymore. For most people, active investing is a loser's game. Minimise losses, put money in index funds, and go back to living your life.
AB: What's the biggest risk right now outside of a 3rd wave or an impending interest rate hike? Or is that the biggest risk? What should investors keep a watch out for?
AD: I worry about inflation the most. I'm old enough to remember when inflation was the last problem and how much pain it took to break the back of inflation. Not just young investors, but central bankers take this casual view of inflation they can control. Like a genie in the bottle, once it comes out -- good luck trying to get it back. Right now, it's an excuse that we're recovering from Covid. A year from now that excuse is done. If inflation is in high single digits, double digits, next year -- God help us! Will drive everything in this game -- rates will go up, stock prices will go down, inflation is one number to watch out for. Fed thinks transient but we will find out one way or the other.
AB: Paytm or Ola? Which of the upcoming IPOs would be of interest?
AD: Depends on how they get priced. I'd prefer Paytm as the ride-sharing business is a disaster around the world. They have figured out how to grow but not how to make money, whether in the US or China or anywhere in the world. There's no stickiness in the market… you'll take an Uber or Lyft, whichever is cheaper. And for the drivers, it's the same way. Paytm has potential… it's a business that is huge… financial services and payment processing. If I can get Paytm at the right price, I would prefer to have that business in my portfolio.
Copyright©2021 Living Media India Limited. For reprint rights: Syndications Today