Lessons from Aswath Damodaran

Aswath Damodaran, a Professor of Finance at the Stern School of Business at New York University, is a renowned figure in the world of finance, particularly for his work on valuation. His teachings, often delivered with a blend of academic rigor and practical wisdom, have influenced countless students and investors.

On Intrinsic Valuation

At the core of Damodaran's teachings is the principle of intrinsic valuation, which seeks to determine the true value of an asset based on its underlying fundamentals.

"The intrinsic value of an asset is determined by the cash flows you expect that asset to generate over its life and how uncertain you feel about these cash flows." [1][2] This is the cornerstone of Damodaran's valuation philosophy, emphasizing that value is a function of cash flows, growth, and risk.
"A firm can have value only if it ultimately delivers earnings." [1][2] This highlights the fundamental truth that a business's worth is tied to its ability to generate profits.
"In the intrinsic valuation chapter, we observed that the value of a firm is a function of three variables—its capacity to generate cash flows, its expected growth in these cash flows, and the uncertainty associated with these cash flows." [2][3] This breaks down the components of intrinsic value into a clear framework.
"A good valuation is a bridge between stories and numbers." [4] Damodaran emphasizes that a compelling narrative must be supported by credible data.
"Valuation that is not backed up by a story is both soulless and untrustworthy and that we remember stories better than spreadsheets." [2] This speaks to the importance of the narrative in making a valuation compelling and memorable.
"All Valuations Are Biased." [5] A crucial reminder that every valuation is influenced by the biases of the person performing it.
"There's a big difference between building an Excel model and valuing a company." [4] Technical skill with spreadsheets does not equate to a deep understanding of a business's value.
"To put a number on something, you can do one of two things, either you estimate the cash flows you will get from owning the business or you look at what other people are paying for similar businesses." [6] This simplifies the two primary approaches to valuation: intrinsic and relative.
"The value of growth assets is a function of not only how much growth is anticipated but also the quality of that growth, measured in terms of excess returns: returns on the invested capital in these assets, relative to the cost of capital." [1] Quality of growth, not just the quantity, is a key determinant of value.
"Discounted Cash Flow (DCF) is the cornerstone of intrinsic valuation. It involves estimating future cash flows and discounting them back to the present using an appropriate rate." [5]

On Price vs. Value and Market Behavior

Damodaran frequently distinguishes between the concepts of price and value, and offers insights into the often-irrational behavior of the market.

"Price is what you pay. Value is what you get." [7] A classic quote that underscores the difference between market price and intrinsic worth.
"Great growth companies can be bad investments at the wrong price." [1][8] A warning that even the best companies can be poor investments if you overpay for them.
"Success in investing comes not from being right but from being wrong less often than everyone else." [2][3] This highlights that investing is a probabilistic endeavor, and minimizing mistakes is key.
"Einstein was right about relativity, but even he would have had a difficult time applying relative valuation in today's stock markets." [2][3] A humorous take on the complexities and potential absurdities of relative valuation.
"In investing, it is crucial to differentiate between price and value, as a price can fluctuate based on market sentiment, while value is derived from fundamental attributes, such as cash flows and potential for growth." [1]
"An investor does not pay more for an asset than it is worth." [1] This is the fundamental rule of a disciplined investor.
"Investment opportunities arise when a stock's price is below its value, with a catalyst on the horizon that could narrow that gap." [7] This provides a framework for identifying attractive investment opportunities.
"The stock market is just a reflection of the value of those businesses that market is sometimes very excited sometimes very pessimistic." [9]
"I see the world in shades of gray, and in a world where more and more people see only black and white, that makes me an outlier." [2] This reflects his nuanced and data-driven approach, avoiding simplistic conclusions.
"In periods of market volatility, doing nothing may be the right choice." [4] Damodaran advises against the compulsion to act during market turmoil.

On Corporate Finance and Company Lifecycle

Damodaran's teachings extend to the core principles of corporate finance, including how companies should manage their investments, financing, and dividends based on their stage in the corporate lifecycle.

"Growth requires reinvestment." [2][3] A simple but profound statement on the fuel for corporate growth.
"Growth firms get more of their value from investments that they expect to make in the future and less from investments already made." [2][3] This explains the valuation focus for young, high-growth companies.
"If growth companies get the bulk of their value from growth assets, mature companies must get the bulk of their value from existing investments." [1] This contrasts the value drivers of growth and mature firms.
"Some of the biggest value destructions in the world happens when companies do not act their age." [10] A warning against mature companies chasing growth at any cost or young companies acting like established players.
"When a company is paying out more in dividends, it is retaining less in earnings; the book value of equity increases by the retained earnings." [2][3] A clear explanation of the trade-off between dividends and reinvestment.
"The Investment Decision: return on assets should be greater than a minimum acceptable hurdle rate." [11] A core principle of capital budgeting.
"The Financing Decision: choose a debt/equity mix that maximises firm value." [11] The goal of capital structure decisions.
"The Dividend Decision: if you can't find investments that meet the hurdle rate, you should return cash via dividends or buybacks." [11] The principle of returning capital to shareholders when profitable investment opportunities are scarce.
"The more you value financial flexibility as a firm, the less you should borrow right now." [10] This highlights the strategic value of maintaining borrowing capacity.
"Avoid companies that are cavalier about issuing new options to managers." [3][12] A warning about potential misalignment of interests between management and shareholders.

On Investment Philosophy and Process

Damodaran provides guidance on developing a personal investment philosophy and the importance of a disciplined process.

"As I see it, the future of investing belongs to those who are flexible in their thinking and capable of moving easily from one segment of the market to another." [2]
"Do not be afraid to make mistakes." [3][8] An encouragement to learn from errors rather than being paralyzed by the fear of them.
"I am naturally drawn to numbers but one of the ironies of working with numbers is that the more I work with them, the more skeptical I become about purely number-driven arguments." [2][12] A testament to the need for qualitative judgment alongside quantitative analysis.
"Falling in love with your own story is always a problem for investors… even as the world delivers facts that are discordant, you stick with your story. My advice is to hang out less with people who think just like you." [4] A warning against confirmation bias and the echo chambers of like-minded investors.
"The key to investing is to remember that if things don't go your way, they don't. There are too many things you can't control. You have to be okay with doing everything right and not getting a reward, but you're okay with it because you enjoy the process." [6] This emphasizes the importance of focusing on a sound process rather than short-term outcomes.
"I think daydreaming is when you open your mind up to hey you know. what can I do that's different what what can I learn." [13] Damodaran values unstructured time for creative thinking and learning.
"There is an advantage to being a more general thinker somebody who thinks about issues on a broader term i will never be able to compete on any topic with a specialist on the topic i don't know enough." [13] He advocates for a broad, interdisciplinary approach to finance.
"Activist value investing: Buy stocks in poorly managed companies and push for change." [14] A specific investment strategy he outlines.
"If you don't bring something to the table. you should not expect to take something away." [9] A reminder that to achieve superior returns, you need a unique insight or edge.
"I'm okay with not beating the market." [9] A statement on the importance of being comfortable with your own investment process, even if it doesn't always outperform.

Additional Learnings and Insights

On ESG: Damodaran is skeptical of the ESG (Environmental, Social, and Governance) movement as a driver of excess returns, arguing that if ESG makes companies safer, they should have lower discount rates and thus lower expected returns for investors. [13]
On Risk: He views risk not just as a danger but also as an opportunity. The question is not how to avoid it, but how to incorporate it into decision-making. [10]
On Macroeconomic Forecasting: He believes that "macroeconomic forecasting makes soothsayers look good." [13]
On Humility: "You want to buy a company because it's undervalued but you'd like to know what is the chances you could be wrong. and if you say there's no chance I could be wrong you're completely missing the essence of equity investing." [9]
On the Source of Returns: "The money is not really made in the stock market the money is made in the real world those businesses go out make things provide services that people want are willing to pay for them." [9]
On Dealing with Market Noise: "There's no point in getting angry at the market or trying to to challenge the market." [9]
On the Importance of a Company's Narrative: "Valuation allows each side to the draw on the other.” [4] The narrative and the numbers should complement and reinforce each other.
On Valuing Young Companies: Key considerations include estimating total market size, the path to profitability, reinvestment needs, and a risk profile with a high initial cost of capital that decreases over time. [5]
On Valuing Mature Companies: The biggest challenge is complacency. Key considerations include the potential for operational improvements, financial restructuring, and valuing non-operating assets. [5]
On Teaching: Damodaran is a passionate educator who makes his courses freely available online, believing in the democratization of financial knowledge. [13][15]

Sources:

Musings on Markets Blog: https://aswathdamodaran.blogspot.com/ [16] and https://aswathdamodaran.substack.com/ [17][18]
NYU Stern Website: https://pages.stern.nyu.edu/~adamodar/ [14]
YouTube Channel: https://www.youtube.com/channel/UCLvnJL8htRR1T9cbSccaoVw [15]

Learn more:

Lessons from Aswath Damodaran

On Intrinsic Valuation

On Price vs. Value and Market Behavior

On Corporate Finance and Company Lifecycle

On Investment Philosophy and Process

Additional Learnings and Insights

Written by Antoine Buteau

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