The transcript from this week’s, MiB: Aswath Damodaran: Valuations, Narratives & Academia, is below.
You can stream and download our full conversation, including any podcast extras, on Apple, Stitcher, Spotify, Google and Bloomberg. All of our earlier podcasts on your favorite pod hosts can be found here.
~~~
ANNOUNCER: This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
BARRY RITHOLTZ, HOST, MASTERS IN BUSINESS: This week on the podcast, I have an extra special guest, returning after a too long of a wait, Professor Aswath Damodaran. What can I say about his breadth and depth of expertise? Start with valuation, what is a company worth and why, move towards what are the things that drive valuations, and then expand out to what happens to valuations over the lifecycle of a company, and why those life cycles are getting increasingly shorter over the past few decades. And then meld in a little psychology and behavioral finance, and you have what is truly a masterclass by one of the great professors in the world of finance. I found our conversation to be absolutely fascinating. I know you will also.
With no further ado, NYU Stern’s Professor Aswath Damodaran.
ASWATH DAMODARAN, KERSCHNER FAMILY CHAIR IN FINANCE EDUCATION, NYU STERN SCHOOL OF BUSINESS: I’m glad to be back.
RITHOLTZ: So let’s start out with a little bit on the work you do. You’re known as the dean of valuation. What led you into that field of study in the world of investing?
DAMODARAN: Can I tell you a little story about —
RITHOLTZ: Sure.
DAMODARAN: — why I am called the dean of evaluation. I was in CNBC about a decade ago and the host had trouble with my last name. He kept trying and trying and trying.
RITHOLTZ: It’s so easy. It runs with Damodaran.
DAMODARAN: Yeah.
RITHOLTZ: Just say Damodaran.
DAMODARAN: Too many vowels so you don’t know which one to emphasize and which one not to.
RITHOLTZ: Right.
DAMODARAN: So, finally, after about his fifth try, he said, I give up. I’m going to call you Dean. And I said, why? He said, oh, dean of valuation, it’s easier to say. So this has nothing to do with expertise. It had everything to do with having an unpronounceable last name. So —
RITHOLTZ: So just for the record, it’s not Damodaran, it’s Damodaran.
DAMODARAN: Exactly.
RITHOLTZ: There you go. I don’t think that’s that hard.
DAMODARAN: Yeah.
RITHOLTZ: It only took me nine times and I got it right. So let’s start with the question, what led you to focus on valuation?
DAMODARAN: I am interested in numbers. I’m naturally a numbers person. But I’ve also been interested in storytelling. To me, storytelling is much more — I mean, if you think about the history of humanity, for thousands of years, the way we pass down information was with stories, not numbers. It’s only in the last century that numbers have come to the forefront.
RITHOLTZ: Is that correct, it’s just the last century? That’s fascinating.
DAMODARAN: In fact, I think the first numbers were collected by the insurance people in the 1700s, but it was very proprietary only. They had the access to loss and excel really. It has allowed for this acceleration of number crunching. So, to me, you know what attracts me to valuation, it’s a bridge between stories and numbers. You tell stories about companies that you convert into numbers, and those numbers eventually become valuations, and I find that attractive. I’m not a natural accountant or an actuary. I’m not a natural strategist who can tell the stories. I like to connect stories and numbers, and valuation is the place to go to do that.
RITHOLTZ: So is it safe to say narratives drive value?
DAMODARAN: Narratives drive value. Absolutely.
RITHOLTZ: Now, sometimes narratives drive value to towns and cities they really shouldn’t go.
DAMODARAN: Sometimes narratives can become very dense (ph), and that’s why you need numbers to keep your discipline. In fact, when I start my valuation class, I have 350 MBAs who take my class and it’s in an amphitheater. I start with the question, how many of you are more naturally number crunchers? And about 200 put up their hands; ex-bankers, recovering accountants, auditors, actuary, scientists, mathematicians. And the other 150 are natural storytellers, liberal arts majors because MBA programs have become incredibly diverse.
And I tell them what my endgame for the class is, I said, by the end of this class, and I turned to my number crunchers, I said, look, I hope you have enough belief in your own imagination that you’re willing to let go because they’ve spent a lifetime being told that being subjective is a weakness, making judgments about something is a weakness. And then I turn to my storytellers, I said, by the end of this class, I hope you have enough confidence with numbers so you’d become a disciplined storyteller.
To me, what makes for good valuation is you’re either a disciplined storyteller or an imaginative number cruncher. And I think that combination is getting increasingly hard to find because we’re very early in life. I see this with my wife who teaches fifth grade, and already people are being slaughtered, natural number cruncher. They’re going to take number crunching classes. We can go for a number crunching degree, have a number crunching job. There are no Renaissance people left on Wall Street, and investing people who can talk about drama and talk about numbers at the same time. And I think that’s a loss.
RITHOLTZ: There are a handful, but they certainly are few and far between —
DAMODARAN: Yeah.
RITHOLTZ: — to say the very least. So you discuss on how all this adds up to a puzzle of corporate finance that you enjoy untangling. What are some of the recent puzzles that you’ve been trying to tease apart?
DAMODARAN: Now, let’s take a basic one. Let’s take buybacks. It’s a story. It’s a political, you know, hotspot, and everybody is talking about it. And I’ve always wondered, why has there been a shift away from dividends to buybacks over the last four decades? It’s incredibly noticeable.
RITHOLTZ: I’m going to write down my answer and you tell me —
DAMODARAN: Yeah.
RITHOLTZ: I’m curious as to what your answer is.
DAMODARAN: Forty years ago, 95 percent of cash returned by companies took the form of dividends. In 1981, when I started, dividends were the way to go for returned cash. Last year, 67 percent of all cash returned by companies took the form of buybacks.
RITHOLTZ: $2 out of $3.
DAMODARAN: $2 out of $3. Collectively, a trillion dollars was returned in the form of buybacks, $550 billion in dividends. Clearly, this is a trend line. It’s not just the U.S.
RITHOLTZ: Around the world.
DAMODARAN: Across the world, you’re starting to see this phenomenon.
RITHOLTZ: So that’s really interesting because what I wrote down was tax efficiency is one of the drivers.
DAMODARAN: Right.
RITHOLTZ: And then we could talk about stock option plans and what is and isn’t above the line deducted. So there’s that?
DAMODARAN: Right.
RITHOLTZ: What’s your conclusion?
DAMODARAN: If I can throw this out to my class, and the first thing they come up with is it more tax-efficient to do buybacks than dividends? And in a sense, it is, but it’s actually less tax-efficient now than it was in 1981. In 1981 —
RITHOLTZ: Really?
DAMODARAN: — when I started, you got dividends. They were taxed as ordinary income at the highest marginal tax rate that was 80 percent.
RITHOLTZ: Right.
DAMODARAN: Capital gains then were taxed with 28 percent. So the question is if tax efficiency is the issue, why weren’t buybacks the dominant way of returning cash pre 1981? And why have they actually increased as, in fact, dividends and buybacks, and now taxed at roughly the same rate? Since 2004, the tax rate on dividends and capital gains is 15 percent, 18 percent, 21 percent. They match up.
RITHOLTZ: Right.
DAMODARAN: So they’re actually less tax-efficient now than it was 30 or 40 years ago, returned cash. The other argument I heard was management compensation —
RITHOLTZ: Right.
DAMODARAN: — and the 19 —
RITHOLTZ: Or general stock option —
DAMODARAN: Exactly.
RITHOLTZ: — influencing dilution and —
DAMODARAN: But if you get restricted stock, the incentives change. With stock options, there’s an argument to be made that you want the stock price to go up because your options are worth —
RITHOLTZ: Right.
DAMODARAN: — worse in the 1990s. The argument was buybacks are happening because we’re increasingly rewarding management with stock options. They have an incentive to do buybacks so that they can get the higher price in the options. So I said, okay, that’s testable. If that is true, buybacks should be greater at companies where management stock options are with higher percentage of compensation and less at companies where management options are not issued.
And I tested that in the 1990s. In fact, that argument didn’t work hard because the companies who were doing buybacks in the 1990s were not the big tech companies. They were older, you know, companies that were over the hill in terms of their business models. And as you well know, in 2007, accountants fixed what I thought was a horrendous mistake —
RITHOLTZ: Right.
DAMODARAN: — in part, which was treating options as free money, and essentially expensing it. And over the last 15 years, and maybe people are not aware of it, companies have increasingly shifted away from options to restricted stock. Last year —
RITHOLTZ: In other words, you get a block of stock that you can sell. There’s a big tax hit for that, right? It’s kind of complicated how you have to deal with it because you’re not selling anything to pay for it —
DAMODARAN: It’s a —
RITHOLTZ: — but it shows up as compensation.
DAMODARAN: It’s a different kind of tax. With options, the tax had gain when you exercise your option.
RITHOLTZ: Right.
DAMODARAN: I remember Mark Zuckerberg, when they went public, had to pay with half a billion dollars to the state of California for options being exercised. But restricted stock has a different set of characteristics, and there, you don’t have the incentive anymore to play with the prices because you’re going to get the shares anyway and you’re going to get the dividends while you get the shares.
RITHOLTZ: Right.
DAMODARAN: If you paid our dividends, you still, even unrestricted shares, get those dividends. So over the last 15 years, companies that used to give options have increasingly shifted away from restricted stock. Another option, so the reason for buybacks, you should have seen a drop-off in buybacks, and we haven’t. So I stepped back and said, what’s wrong with dividends? And let’s face it, dividends really never made sense as a way of returning cash to equity investors. Why?
RITHOLTZ: If you’re a long-term investor, you want to see the capital —
DAMODARAN: But, also, if you think about equity as a residual claim, which is the way I think about it, you get whatever is left over. Then that residual claim should change year to year, whereas dividends, historically, have been sticky. They’re like coupons on bonds. And the only reason I can think for why dividends became the key way of returning cash is I went back to the history of markets. Bond markets preceded stock markets. So when stock markets were first open, to attract investors to buy stocks, they had to be disguised as bonds. So —
RITHOLTZ: Meaning, you had a coupon.
DAMODARAN: Yeah.
RITHOLTZ: It was fairly reliable.
DAMODARAN: Exactly.
RITHOLTZ: And if you had a little upside on the equity —
DAMODARAN: Exactly.
RITHOLTZ: — fantastic.
DAMODARAN: You can go look at the original railroad stocks, you put a dividend in to get investors who are buying bonds. This is just like a bond with price appreciation. This is one reason I’m a little skeptical about people who claim that they do their investing based on Ben Graham’s “Security Analysis.” It’s a great book, but it reflects the time it was written.
RITHOLTZ: A little dated? Is that —
DAMODARAN: It was 1934. It reflects the risk aversion of somebody coming off the Great Depression and things of stocks as bonds with price appreciation. That’s a Graham approach investing, buy a bond with price appreciation.
RITHOLTZ: So let’s combine two things that you said. One is your love of narrative as a way of explaining numbers; and the second is you mentioned railroads. I want to just reference what we see in terms of pushback to buybacks. And from the ‘90s, anecdotally, and I know the plural of anecdote is not data, but anecdotally, we always used to see the worst time stock buybacks heading into 2000. It seemed like the buybacks got bigger and bigger. Management tends to be terrible timers. So I used to hear that all the time. Then you have the railroad crash and a big stock buyback instead of a safety upgrade. And so, these stories seem compelling, even though they don’t reflect the totality of all the buybacks out there.
DAMODARAN: And I’m glad you brought up Norfolk Southern because my most recent post on buyback starts with two stories. One is the Norfolk Southern story and how that initiated again this discussion of our buybacks happening at the expense of reinvestment of things you need to put back. And the second was, of course, the Warren Buffett story that came out the same week, where he essentially called people who post buybacks, you know, economically illiterate. I mean, strong words for Buffett. And again, some history, until 2009 or ‘10, Warren Buffett actually spoke out against buybacks.
RITHOLTZ: He was not a fan.
DAMODARAN: He was a big dividend person. And then in 2012, I think Berkshire Hathaway initiated its buybacks with a cap, which is, you know, that they will do buybacks as long as the price was less than intrinsic value.
RITHOLTZ: Now, is that a function of Berkshire Hathaway having so much cash and not a lot of reasonably priced acquisition targets?
DAMODARAN: And I think here’s where I think the real reason for the buybacks comes in. Dividends because they’re sticky, requires some degree of confidence about future earnings. Now, when I started in 1981, I actually made a list of 200 U.S. companies with reliable and predictable earnings. It was easy to do. You had, you know, this data —
RITHOLTZ: Telephone companies, utilities, FANG.
DAMODARAN: Telephone companies, consumer product companies.
RITHOLTZ: They used to call them widow-and-orphan stocks.
DAMODARAN: Exactly. A big brand name companies, and I made a list and it was easy to do. Today, if you ask me to make a list of 20 companies with reliable and predictable earnings, I’d have difficulty.
RITHOLTZ: Twenty? You can’t get 20?
DAMODARAN: Because everybody’s business is under disruption. Everything is changing. I mean, welcome to globalization. There’s a dark side to globalization. And one of the dark sides of globalization is business has become more unpredictable. Earnings have become less predictable. And if earnings become less predictable, what company in its right mind wants to increase dividends by 20 percent and then face the problem two years later of saying, we’ve been disrupted, we have to go back and cut dividends.
I think of buybacks as flexible dividends. That’s the way I think about it, and that’s a good thing. In the first quarter of 2020 when COVID shut the global economy down, everybody felt that the right thing for companies to do is hold back cash.
RITHOLTZ: Right.
DAMODARAN: But companies —
RITHOLTZ: So that means no dividends, no buybacks.
DAMODARAN: Yeah, of course, because you got to wait this out. And if you look at buybacks, that’s exactly what happened. Companies announced that they were cutting back on buybacks, and buybacks had already announced we’re going to be suspended. Buybacks dropped by 50 percent in that quarter.
RITHOLTZ: Which, ironically, would have been a great time to buy some stock.
DAMODARAN: Exactly. We’ll come back to the timing issue. But dividends continued as if nothing was happening because —
RITHOLTZ: Oh, really?
DAMODARAN: — companies were terrified. And this is the problem, companies are so attuned to this notion of you can’t cut dividends, that when a company actually cuts dividends, it’s usually because there’s disaster on the horizon. So you’re actually stuck with a dividend. You’re a hotel company, you’re paying a dividend. You’re continuing to pay a dividend because you don’t want to send the wrong signal. My reaction is, are you in denial? Because everybody around you knows that you can’t run your business. But that’s the problem with dividends, it’s the way we’ve created dividend policies. And let’s face it, value investors have fed into this addiction by saying, I buy the stock because it never cuts dividends.
RITHOLTZ: That’s really interesting. I have a vivid recollection, when I was new to investing in the mid ‘90s, of finding these giant yielding companies, 8, 9, 10 percent, not realizing until someone pulled me aside and said, here’s what’s going on. Hey, these were 2 percent dividend companies until they got shellacked. And even though they’re circling the drain, they’re still afraid to cut the dividend, and that’s why it looks like it’s a 9 percent yield. That dividend is eventually going away.
DAMODARAN: Yeah.
RITHOLTZ: We can’t still see that anymore. That’s got to be history, right?
DAMODARAN: Last year, there were at least a couple hundred companies with dividend yields greater than 8 percent. And the way I think of them is these are companies —
RITHOLTZ: Wow.
DAMODARAN: — that are teetering on the edge of the cliff. And if you’re a lazy value investor buying high yields, you’re going to be buying a lot of banks right now.
RITHOLTZ: Right.
DAMODARAN: A lot of regional banks right now have dividend yields of 6, 7, 8 percent. But if you load up your portfolio with those, God only knows what a year or two from now you’re going to be looking at because these companies are going to be forced to cut their dividends.
RITHOLTZ: Right.
DAMODARAN: Right? This is not even a question, it’s not a choice, they’re going to be forced to cut their dividends. You’re just buying them just ahead of the precipice, and it’s not a great way to invest as a reason. But, to me, that is what I think about as a puzzle. When I look at a company doing something and I say, why is that happening, I want to generalize the discussion because it’s easy to get trapped in an anecdotal story and draw conclusions that don’t apply to the population. And you probably saw the story about Musk lowering the Twitter valuation to —
RITHOLTZ: Right, the $20 billion for the stock options to staff that —
DAMODARAN: And that’s an interesting question when, first, is this a gaming of the system? Are you setting yourself up for the great recovery story?
RITHOLTZ: Does he get a write-down?
DAMODARAN: Does he get a write-down? So there’s the taxes that I am puzzled, but I’m curious. I want to find out, and I’m digging as much as I can because we do know that Fidelity took a 56 percent write-down on their investment in Twitter.
RITHOLTZ: That’ll help finance the purchase.
DAMODARAN: Yeah, that’ll help finance. So they invest in the equity. They took a 57 percent write-down which is suspiciously close to the knockdown you’re seeing from $44 billion to $20 billion.
RITHOLTZ: Right.
DAMODARAN: So I always wonder about these accounting firms that reappraise price. They don’t reappraise value. They reappraise price. What they base it on, probably —
RITHOLTZ: Say that again. They don’t reappraise value, they reappraise price.
DAMODARAN: Yes.
RITHOLTZ: And I suspect you think they should be reappraising value.
DAMODARAN: I don’t think they have the tools, to be quite honest. I’d rather have an honest pricing than a kabuki dance valuation because it goes back to this issue of fair value accounting. Fair value accounting is not about value. It’s about pricing. In fact, if you look at FAS 157, which lays out the principles of fair value accounting, you’re supposed to come up with the number that you can get if you sold in the market —
RITHOLTZ: In the market. Right.
DAMODARAN: — to a participant on an arm’s length transaction.
RITHOLTZ: Right.
DAMODARAN: That’s a pricing mission.
RITHOLTZ: Right. Market price.
DAMODARAN: Market price.
RITHOLTZ: How hard is that?
DAMODARAN: So in a sense, that’s what these accountants are doing. And presumably, they mark down the pricing based on revenues dropping by 57 percent. It’s as simplistic as that.
RITHOLTZ: Right. Do we really think Twitter could be sold today for $20 billion?
DAMODARAN: I think it could be sold to somebody with deep pockets because, let’s face it, you know, you just got 350 million users. And —
RITHOLTZ: Right.
DAMODARAN: — you know, I’ve never seen a social media platform become so much a part of our lives, with a pricing and a business model that doesn’t seem to work.
RITHOLTZ: Right.
DAMODARAN: This has been the problem right from the beginning. And I think part of the reason is the nature of the platform doesn’t lend itself easily to the way you make money. It’s not good for a subscription model.
RITHOLTZ: Right.
DAMODARAN: Let’s be honest finding out, right?
RITHOLTZ: Right.
DAMODARAN: The 3 percent of people who send out 90 percent of tweets, you might get them, but you can’t make enough money on that 3 percent to cover the business. It’s not a great advertising model —
RITHOLTZ: Right.
DAMODARAN: — partly because what makes it attractive, which is limits on characters, also limits you in terms of advertising. People are hitting and running. They don’t sit and read. Whereas on Facebook, I can get to you while you’re spending an hour talking to your friends.
RITHOLTZ: Right.
DAMODARAN: So it’s a difficult social media platform to monetize. Jack Dorsey found it out, you know —
RITHOLTZ: Right.
DAMODARAN: — and subsequent people there found it out. I am not sure it can ever be monetized successfully. I would not buy it as a business.
RITHOLTZ: Right. What Elon should do, and by the way, I’m very good at giving advice to billionaires, whether they want it or not, it should be like a Craigslist or a Wikipedia, put it into a foundation for the public good. And if you really want it to be a public square, don’t monetize it —
DAMODARAN: Yeah.
RITHOLTZ: — just sell enough advertising so it’s a break even.
DAMODARAN: And maybe there’ll be a $20 billion write-off in his next big —
RITHOLTZ: Or $44 billion.
DAMODARAN: Or $44 billion write-off.
RITHOLTZ: I think he could use the tax write-off.
DAMODARAN: He can write off only the equity portion of $44 billion.
RITHOLTZ: Not the debt.
DAMODARAN: The write-offs are going to be the banks writing it off. So that’s, I think, the reality of this —
RITHOLTZ: Wow.
DAMODARAN: — is I think that is absolutely true. I think Twitter plays a role in our lives, which for many people, I think they — you — we get our news on Twitter first, right?
RITHOLTZ: It’s the new tape. Absolutely. It’s where news breaks.
DAMODARAN: Yeah. I’ve heard that, you know, the quarterback for Baltimore wants to leave. The first place you read it —
RITHOLTZ: Right.
DAMODARAN: — is he posts it on Twitter, Lamar Jackson, now, I’m looking for another place to be. So I think it has become this breaking news place. Journalists track Twitter because they get their news stories often from Twitter.
RITHOLTZ: Very much so. I had a flight back from California and I’m catching up in Season 3 —
DAMODARAN: Okay.
RITHOLTZ: — of “Drive to Survive,” the F1.
DAMODARAN: Yeah.
RITHOLTZ: And one of the drivers is leaving to take a gig with another of the F1 teams, and he makes that announcement on Twitter. It’s where people go. It very much could be the public square.
DAMODARAN: Yeah. And I think that’s where it might end up, but it might need somebody take a big write-off before it ends up here. I mean, I’ve given up on trying to figure out Elon’s motives in doing something. But I think, in a sense, there is a portion of honesty in his motives (ph) as he wanted a public forum. He wants it on his terms. That’s wrong. He wants it in his terms.
But I think that there is an argument to be made that Twitter, as it was developing, would never make it as a successful business, that maybe there’s a pathway for it to become a part of our lives, more like one of those regulated utilities, which we know —
RITHOLTZ: Right.
DAMODARAN: — we are so dependent on. But they’re not going to have the growth and the monetization potential —
RITHOLTZ: Right.
DAMODARAN: — that people might have seen it originally. ]
RITHOLTZ: So I have a pet theory about Elon. We’ll —
DAMODARAN: Yeah.
RITHOLTZ: — come to it later. What I wanted to really circle back to is you were describing the difference between price and valuation, and it kind of raised an idea in my mind, how far behind the academic research, the most current academic research, do you find Wall Street finance the investment community because my favorite examples, modern portfolio theory, capital asset pricing model, the Fama-French factor model. It seemed like the market took a decade or longer to catch up. Is that gap still there, especially when it comes to how do we properly value this company?
DAMODARAN: It’s interesting. The models catch up faster than the underlying logic. There are a lot of people who use betas now.
RITHOLTZ: Right.
DAMODARAN: But they don’t understand the core assumption you need to get to beta as being a measure of risk, which is you got to assume that investors have a diversified view of risk, that when they think about the risk in a company, they don’t think of the risk of the company standing alone, but the risk it adds to a portfolio. That is the core —
RITHOLTZ: Right.
DAMODARAN: — idea behind all of modern portfolio theory.
RITHOLTZ: Sharpe ratio, all the work Bill Sharpe has done.
DAMODARAN: And the reason I make that claim is I see people on three stocks who might use beta, and I said, look, are you sure you want to use beta to measure risk because you’re violating the core assumption, and they’re not even sure what I’m talking about. And to me, the models make it, in fact, much more quickly than they should because I want the intuition to get out there first, the logic to be debated first, before you adopt the models.
Greed drives everything. So if somebody sees a factor model, and they see a factor making money, there’s an ETF that’s get founded on the factor.
RITHOLTZ: Right.
DAMODARAN: Nobody stops and ask the question, why is that factor giving me higher returns? What is the underlying logic? Small cap, right, for a long time, people bought small-cap stocks because they say, oh, you’d make the return. And I’d stop and ask, why do you think small-cap stocks earn a higher return? The original research actually, the Fama-French paper argued that market capitalization was standing in as a proxy for us, that small companies were riskier than larger companies.
RITHOLTZ: Right.
DAMODARAN: You weren’t really making higher returns. You just looked like you were making higher returns and beating the models. But, in fact, you’re exposed to risk.
RITHOLTZ: On a risk-adjusted basis, it’s the same.
DAMODARAN: And that’s exactly right. But you’d look at for the alphas who calculate it because people were using outmoded models to measure risk, and you could beat those models. So you could game the system to create positive alphas by looking like you are beating, when, in fact, you were just buying small-cap stocks. So Fama-French were not saying you should invest in small-cap stocks. They were saying when you invest in small-cap stocks, it looked like you’re making money, but there are underlying risks, liquidity risks, information risks.
RITHOLTZ: Right.
DAMODARAN: But —
RITHOLTZ: Not as covered on Wall Street, less info.
DAMODARAN: But an ETF gets funded the next year on small-cap stocks. People forget all about the risk story.
RITHOLTZ: It becomes an alpha story.
DAMODARAN: Everything in Wall Street becomes an alpha story. I mean, we might get to ESG. This is, I think, at the core of why ESG has floundered, is somewhere in the middle of the last decade, people decided we’d sell better if you sold it as an alpha story. So they told people if you invest in good companies, you will make higher returns. I mean, this is the —
RITHOLTZ: Hold that thought because —
DAMODARAN: Yeah.
RITHOLTZ: — we’re going to definitely come to ESG. Let’s stay with small cap for a second. The most recent academic research I read that I thought was kind of compelling was sort of small cap within the small-cap story. So, first, the small-cap factor kind of went away because it was really risk. It wasn’t actual returns. And then the update was, well, if you’re looking at small cap, most of returns are driven by the micro-cap.
DAMODARAN: Right.
RITHOLTZ: And so that it’s not the small cap. So is there micro-cap alpha, or is that also a risk-adjusted story?
DAMODARAN: And it gets even stranger than that, and much of it is delivered in the first month of the year. You know, 90 —
RITHOLTZ: Because of the January effect.
DAMODARAN: The January effect. So there’s something weird going on here, right? I mean, it’s been going on for the longest time.
RITHOLTZ: So people dump a bunch of junk.
DAMODARAN: Who knows, right?
RITHOLTZ: They don’t want to show on their books in December.
DAMODARAN: That’s the reason I said buy before December 31st.
RITHOLTZ: Right.
DAMODARAN: You get rid of those low profile stocks in your portfolio.
RITHOLTZ: That looked bad.
DAMODARAN: That had looked bad. So you essentially push the price down, and then January comes around and you buy back those stocks, the price goes up. Whatever the reason, I would not invest based on the small-cap phenomenon precisely because it’s so weird. It doesn’t happen over the course of the year. It doesn’t happen in a cross-section. It’s a small subset of companies.
RITHOLTZ: Right.
DAMODARAN: But here’s where it’s staying with our notion of how badly academic theory gets transitioned into practice. If you ever talk to people who appraise small companies, the way they appraise, they come up with a discount rate, is they use the traditional models, risk-free rate beta risk premium. They come up with a number and then they will add a small-cap premium.
RITHOLTZ: A premium?
DAMODARAN: Four percent more to push up the discount rate for small companies. So if you own a private business and you go to Duff & Phelps, or you go to Ernst to value my business, they’ll come up with a 12 percent discount rate. So we’re going to add a 6 percent small-cap premium to it. You’ll say why. Because remember that 18 percent discount rate means a lower value for your business.
RITHOLTZ: Right.
DAMODARAN: You’ll say, why are you doing that? Because there’s a small-cap premium. It’s academically proven. They pull out papers and, look, there’s a small-cap premium. It’s roughly 6 percent. That’s extraordinarily sloppy. You’re dropping the value of every small-cap company —
RITHOLTZ: Right.
DAMODARAN: — because you think they’re all hit with that same bludgeon. There was actually a very interesting paper that came out of AQR, and I think Lasse Pedersen is one of them and he argued that it’s not a small-cap premium, it’s a small-cap junk premium, which basically means that it’s small-cap companies that are of high quality that are earning much of the premium. So if you put your money across a hundred small-cap stocks and you’re just investing in all 100 of them, you might end up with a portfolio that does not think —
RITHOLTZ: You need small cap and quality.
DAMODARAN: And at that point, you’re saying what’s a small cap got to do with anything?
RITHOLTZ: Right.
DAMODARAN: I would argue that if you did a quality effect across the board, you’re probably going to find a quality effect in large-cap stocks and mid-cap stocks. So I think this is one of those cases where the academic research veered off in one direction, but the practitioners using the research found ways of making money on it. And in the process, it’s taken on a form that none of the academics who might have done the original research would even recognize. So I think that it’s not that research takes a long time to go into practice. I could live with that. It’s the way it gets skewed and morphed.
RITHOLTZ: It’s worse than delayed.
DAMODARAN: It’s worse than delayed.
RITHOLTZ: It’s misconstrued.
DAMODARAN: I think it actually ends up doing more damage than good when it goes into practice. I’d much rather that I — that practitioners never read academic research and try to put into practice because in the process of putting into practice, they just ruin it.
RITHOLTZ: So let me give you one —
DAMODARAN: Yeah.
RITHOLTZ: — that I hate —
DAMODARAN: Yeah.
RITHOLTZ: — and it’s now an ETF.
DAMODARAN: Yeah.
RITHOLTZ: Someone did a study, some academic research did a study that found that if you only held stocks during market hours, you underperform holding stocks from when the market is closed. And I thought that, well, aside from the fact that the market is only open six and a half hours a day, hold that aside, all the gap-ups, all the news that breaks after, it just seemed like such a silly concept. And now, there’s an ETF. I’m curious what your thoughts are on —
DAMODARAN: I think it’s nonsense.
RITHOLTZ: Nonsense.
DAMODARAN: It’s nonsense. I mean, my argument, when I look at an ETF analysis, is if everybody can do it —
RITHOLTZ: Right.
DAMODARAN: — then I can almost guarantee that —
RITHOLTZ: Then it’s going to get arbitraged with.
DAMODARAN: If it really exists, it get arbitraged with.
RITHOLTZ: Okay.
DAMODARAN: So to begin with, everybody knows what the open hours to the market, right? This is no secret information.
RITHOLTZ: Right.
DAMODARAN: You’re not finding anything particularly valuable. I mean, in investing, you got to bring something to the table —
RITHOLTZ: Right.
DAMODARAN: — to take something away. That’s my view.
RITHOLTZ: You have to bring something to the table, you have to bring some new insight in order to take some alpha away.
DAMODARAN: Or it could be some unique characteristic, pension funds pay no taxes.
RITHOLTZ: Right.
DAMODARAN: That should give them an advantage —
RITHOLTZ: Enormous advantage, right?
DAMODARAN: — subsets to the market.
RITHOLTZ: Plus, they’re perpetual.
DAMODARAN: So if they buy dividend-paying stocks, they should be able to earn higher returns on a post-tax basis because their tax is zero, right?
RITHOLTZ: Do they?
DAMODARAN: Well, they tried to be clever. The problem is momentum is such a strong force that everybody chases it.
RITHOLTZ: Right.
DAMODARAN: If they’re not going for the stock, they should go for it, given their niche properties. They go for stocks that everybody else is buying, but —
RITHOLTZ: And therefore, they perform —
DAMODARAN: Yeah.
RITHOLTZ: — as everybody else does.
DAMODARAN: And in fact, you know, let’s use Berkshire Hathaway to illustrate how a niche can be exploited well. To me, one of the reasons Warren Buffett succeeded, he has a lot of good qualities brought in. One of the reasons he succeeded is the money he was investing. And if you think about the money he was investing, he’s been investing insurance company premiums that are collected.
RITHOLTZ: Right. Low cost capital —
DAMODARAN: Low cost —
RITHOLTZ: — with a perpetual account.
DAMODARAN: — and it doesn’t panic.
RITHOLTZ: Right.
DAMODARAN: That’s a huge plus, right? So when he bought Goldman Sachs in November of 2008 and Bank of America in November 2008, I thought about a traditional portfolio manager doing the same thing and trying to explain to their clients what they just did.
RITHOLTZ: They would have gotten fired.
DAMODARAN: They’ve gotten fired. So what the heck are you doing in the middle of a crisis? But —
RITHOLTZ: Right. But that’s the time to buy discounted quality.
DAMODARAN: But if you have capital that doesn’t panic, it’s driven by the actuarial tables, you can go out and take positions in these companies and say, I don’t have to worry about my clients asking me tough questions because my clients are the actuarial tables. The question is if he can do it with insurance company money, why can’t all state and state firm and other insurance companies do the same thing?
RITHOLTZ: What’s your answer?
DAMODARAN: Because the answer is an average portfolio manager is driven by emotion and mood.
RITHOLTZ: Right.
DAMODARAN: They talk the value investing talk.
RITHOLTZ: So let me expand that. It’s not just insurance companies. Why can’t foundations and endowments and you know, go down the list of entities that has capital, that shouldn’t panic, and has a hundred-year investment horizon?
DAMODARAN: Because they’re run by people who are still judged on a year-to-year basis.
RITHOLTZ: So as soon as chatbots take over running portfolios, we should avoid this panic, or they’re just going to pick up the panic?
DAMODARAN: Because chat bots are going to just reflect human behavior.
RITHOLTZ: It’s just the same.
DAMODARAN: That’s why I’m not so upbeat about chatbots doing the right thing. They’re going to mimic human behavior. And guess what, humans behave in some really bad ways, especially during crises. So chatbots are going to just magnify that process. If you think this is going to make us more rational, it’s not. In fact, you have to create a counter chatbot that says, tell me what I should be doing, and then I’ll do the exact opposite.
RITHOLTZ: Inverse chatbot ETF.
DAMODARAN: Yeah.
RITHOLTZ: You know, that’s a product that I would buy. I like it.
DAMODARAN: Yeah.
RITHOLTZ: Quite fascinating,
(COMMERCIAL BREAK)
RITHOLTZ: So let’s talk a little bit about academia. You’re not the typical tenured professor. Aside from the fact that you’ve won tons of award and been voted best professor at Stern over and over again, you’re very open source. You have a blog. You’re very active on Twitter. Both of these are a little unusual in academia. Tell us why you approach the world that way.
DAMODARAN: I’m often asked what I do for a living, and I say I’m a teacher. That’s my passion. It’s not the valuation. It’s not corporate finance. I’m a teacher, first and foremost. I tell people if I wasn’t teaching valuation and corporate finance, I’d be teaching high school algebra. Teaching is my passion. Corporate finance and valuation are the things that I used to kind of exploit that passion.
And that puts me at odds with traditional academia because, unfortunately, I think universities have lost their core mission. To me, the core mission of universities should be educating the students who go through —
RITHOLTZ: One would think. Right.
DAMODARAN: One would think. But if you’re a research university, the mission is muddled. And the mission is muddled because you get measured on the reputation of your faculty, with their peer group, and what kind of research they do. And I tell people if you think about the constituencies the university serves, you’d expect undergraduate students to be at the top of the list, especially at universities like NYU, where our money primarily comes from tuition. These are your customers, right?
But if you actually look at decisions made at the university, and you look at where undergraduate students fall on that list, they’re not even on that list. At the top of the list are tenured faculty. I mean, I describe universities as lunatic asylums where the inmates run the asylum.
RITHOLTZ: Right.
DAMODARAN: And because of that, universities do things, where an outsider looks at university and say, how the heck do you guys get away with this? And I’m going to give away a secret, as a professor to research university, my teaching load is three courses a year. That translates into four and a half hours a week for 30 weeks a year.
RITHOLTZ: That’s pretty light.
DAMODARAN: That is light. That’s it. I know you’re supposed to keep the extra time for research. But once you’re tenured, there’s no —
RITHOLTZ: You’re landed gentry.
DAMODARAN: The landed gentry. And if you think about how much it costs to pay a faculty member who works four and a half hours a week, then you can very quickly start to untangle why it costs a student $50,000 a year as tuition.
RITHOLTZ: So you’re implying it costs 10 times as much as it should if people were legitimately —
DAMODARAN: Yeah. If you were just paying for education, it should be one-tenth of that. And I think that, you know, of course, university education is not just courses. That was the mistake that edX and Coursera made when they first decided they’re going to disrupt the education business by packaging these MOOCs. Remember the big online course —
RITHOLTZ: Yup.
DAMODARAN: — that was supposed to change education? It never quite caught on because an education is a collection of things. It’s the courses you take. It’s the network you create. It’s the entertainment value. Let’s say you go to Notre Dame.
RITHOLTZ: Right.
DAMODARAN: That Sunday football is a big part of your life.
RITHOLTZ: Right.
DAMODARAN: And most of all, it’s parents sending their kids off to a place where they can do stupid things for four years and not get into too much trouble.
RITHOLTZ: Right.
DAMODARAN: I mean, let’s face it, if you have a child at the age of 18 to 22, you know they’re going to do stupid things.
RITHOLTZ: Right.
DAMODARAN: This speaks stupidity that made them —
RITHOLTZ: That’s the purpose of college, right?
DAMODARAN: And you send them off to a nice college campus, they can do stupid things on campus, and the college kind of covers up for that stupidity. So I think in a sense, you’re buying a package. It’s like the old cable model. You bought this package. It’s going to cost you $50,000 a year, and because you couldn’t untangle the different pieces, you pay because you had no choice.
I do a session called Barbarians at the Gate for universities. I said, look, just as the cable companies ended up with this unbundling of the product —
RITHOLTZ: Right.
DAMODARAN: — where people said, you know what, I can just get the channels I want by paying directly for them, and that kind of untangled the cable business. Untangling is coming to the education business. People are going to be able to buy the network. LinkedIn is, in fact, a very good substitute for going to college and spending four years hanging out with people who might never get back to you when you try to reach out to them.
So essentially what technology is doing is it’s unbundling the university model. And over time, it’s going to eat away the university model. Universities are actually contributing to their own disruption. Georgia Tech, for instance, allows you to take courses for a fee. It does a very good job. And it’s a good revenue generator, but you’re already digging a hole for your own demise as a university because once you start unbundling courses and offering them, people can start pricing them out. I’m paying for five courses in MBA. I’m paying $50,000, but you’re offering the same five courses online for $2,000 apiece. Five times 2,000 is 10,000. So what’s the extra 40,000 for? Unbundling basically, then makes it transparent that you’re charging this hefty premium.
The only thing universities have going for them that’s going to make disruption slow is parents. I mean, if your 18-year-old came to you and said, look, dad or mom, you know, I can educate myself by taking all these courses online. Most parents are probably still going to say, that’s not education. You got to — because we’ve been trained —
RITHOLTZ: Because that’s the only point of college.
DAMODARAN: Yeah. We’ve been trained. It takes four years. You go to university. There’s a degree that comes with this, and there’s a screening process that goes with it. So I think the reason disruption has been so slow to come to education is because the people who make the decisions in education, which still are the parents, not the kids, have been trained to believe that you have to go to university, go for four years to get a degree. But that’s going to change now.
RITHOLTZ: So let me throw a quote of yours back at you —
DAMODARAN: Yeah.
RITHOLTZ: — and get some feedback. I’m very amused by this, quote, “This will get me shunned in the academic world, but who cares? I don’t do academic research or write to be published anymore. Life is too short to be spent writing for an echo chamber and rewriting to meet the often arbitrary demands of a reviewer. I write only on topics that; A, interests me, and B, may be useful to practitioners.” Explain.
DAMODARAN: I —
RITHOLTZ: Like, aren’t you basically thumbing your nose at the entire publish or perish world of academia now that you’re a tenured professor?
DAMODARAN: Yeah. I think there’s a degree of hypocrisy there, right? Because I did get tenure and it was based upon papers that I don’t even remember what I wrote them on, right? I mean, that tells you a little bit about what academic research is about. It’s as a discipline ages, and this is I think key, you have to start to ask smaller and smaller questions to be able to get published.
Let’s take the example of physics a hundred years ago or more. Einstein and Bohr were asking the big questions; how does the universe get created? What drives it? Today, if you look at a physics journal, they’re asking questions you don’t even understand the title of the paper because it’s such a small question. There are seven co-authors. That’s the other thing that seems to happen as disciplines age —
RITHOLTZ: Right.
DAMODARAN: — is use this power of numbers, one of whom might have connections to a reviewer, so you add them on. And they’re asking questions that to be quite honest, nobody cares about, including physicists because the question is so narrowly phrased that you say who really cares?
RITHOLTZ: Well, now that we know how the universe was created, we can’t spend any more time on that.
DAMODARAN: Exactly. But even if you have questions because we really still don’t know how the universe was created —
RITHOLTZ: Of course.
DAMODARAN: The only problem is we write a paper on it, it’s too big to get published because there will always be loose ends.
RITHOLTZ: Right.
DAMODARAN: You know, people are going to pick up the loose ends, probably say, this can’t be published, it’s not quite ready to be published. So as disciplines age, unfortunately, the research becomes less and less useful to not just the outside world, but even the inside world. And for some people, they still have enjoyed doing research. I don’t begrudge them that. So there are some of my colleagues who are still curious about academic questions.
But I discovered very early in my life that this wasn’t my strength, picking some obscure academic topic, spending six months of my life writing a paper that dotted i’s and cross t’s. I’m a teacher and I want the biggest audience I can. So I think of everything I do as an extension of teaching, including almost all of my writing. And I want the biggest audience I can, so why would I restrict my audience to just people in my classroom or just people in an echo chamber? So it’s very selfish. I want to reach the biggest audience because as a teacher, you want the biggest audience, and this gives me a way of making an audience larger.
RITHOLTZ: So what sort of pushback did you get from the academic community to the statement which seem to have resonated in certain quarters?
DAMODARAN: I don’t hang out with the academic community enough to even know because it had a —
RITHOLTZ: I get back to you, the social world things —
DAMODARAN: But, in a sense, I was labeled a teacher, professor early on. In fact, my chair —
RITHOLTZ: Almost disdainfully.
DAMODARAN: Yeah, by some. But for some, remember I’m carrying —
RITHOLTZ: It should be a compliment.
DAMODARAN: I teach a class of 350 people —
RITHOLTZ: Right.
DAMODARAN: — so I’m carrying a load that actually allows them to do what they want to do, which is go back to research. So from a selfish rationale, for them, this is actually good. I was taking this thing that they did not like to do. I was doing it for them, and I was doing it with joy because this is what I do. So it serves us both. I don’t begrudge them in their research. They don’t begrudge me in my teaching. We’ve learned to live, at least, at NYU, and part of the reason I like being at NYU is it’s a very large faculty. It’s a very diverse faculty. So I’ve always been allowed to do what I want to do.
Could I have done what I did at University of Chicago or Stanford? Probably not. And I think that basically means that if your joy is teaching and you want to be in academia because you want to teach, you want to pick a place where that’s not just valued, but that you get the freedom to be able to focus on teaching and getting a message out to practitioners, you know.
RITHOLTZ: So there’s a couple of attempts at disrupting education, one of which, and I’m drawing a blank on the name, is you could take up to, let’s say, it’s 12 credits a semester —
DAMODARAN: Right.
RITHOLTZ: — you could take 48 credits online over two years, at no cost, and these are accredited. And when you go to a college, you could cut your college costs in half.
DAMODARAN: Right.
RITHOLTZ: You go to college for your junior and senior year, transfer these credits in. Is that the same experience then as to what you were describing? So going to school for four years, making that social network, making contacts, learning how the world operates in a way that you can’t when you’re just at home looking at a computer?
DAMODARAN: These are called hybrid models, and a lot of universities have adopted them, not just for undergraduate degrees, but for executive programs. Executive programs, historically, have been very expensive to go to. But to create these hybrid programs, you take classes online. But one week a year, everybody in the program is brought in to a physical location so they can hang out together, live in the same place. That’s a networking benefit.
So you are going to see hybrid programs, and that’s going to be the transitional point. Because doing an education entirely online is tough to do because people lack self-discipline. I know even though I offer my classes online and I start the classes off, about 50,000 people start the class with me, I can watch them by session because I got 26 sessions.
RITHOLTZ: Right.
DAMODARAN: And by the time I get to Session 26, I can actually track how many of the 50,000 is still there.
RITHOLTZ: What’s the attrition rate like?
DAMODARAN: It’s huge. It’s 90 percent.
RITHOLTZ: Wow.
DAMODARAN: Because people have lives to live. My class requires a lot of time and resources.
RITHOLTZ: Sure.
DAMODARAN: And it’s 80-minute session. So even if you just watch the lectures, that’s three hours every week of just watching the lectures.
RITHOLTZ: Right.
DAMODARAN: Forget about the other stuff. So that’s why I created an online version of my class, where I take my 80-minute lecture, and I think about how would I deliver that lecture if I had only 10 minutes?
RITHOLTZ: Wow.
DAMODARAN: And the scary thing was it wasn’t that difficult, which tells you a little bit about how much buffer as faculty members or as professors you get.
RITHOLTZ: Is buffer the right word? Are you just taking an example and going into detail —
DAMODARAN: Yeah.
RITHOLTZ: — and nuance that you don’t get in 10 minutes?
DAMODARAN: It’s a lot more. I can tell stories. I can flash that. So I’m not saying the extra 80 minutes are useless, but I’m saying that 10 minutes is where you get the substance. The extra 80 minutes away, you get the dressing on the substance. And you could probably get that dressing in small pieces if you want because when I do my YouTube videos and blog posts, you’re essentially seeing things that will show up as riffs in my class.
So the post I did on Tesla a couple of months ago, where I valued Tesla and asked, you know, how do you explain what’s happening at Tesla, and how do you bring in these new businesses? That becomes a part of my class somewhere. So I tell people, look, start with a 10-minute session. That’s a realistic estimate. You can actually get through the sessions.
And if this truly interests you, then try out this. I create these concentric circles for people who have time and say, if you have this much time, try these extra things. If you have this much time, go the extra mile. So I think by creating enough flexibility, you’re going to be able to allow people to do things online that they can’t do right now.
RITHOLTZ: So you give them the core film and the DVD extras, and they could choose how much they want.
DAMODARAN: Exactly.
RITHOLTZ: So you also mentioned you’re at the intersection of three businesses; education, publishing, and financial services that are all inefficiently run and deserve to be disrupted. What are the similarities between these three areas? And can we not say that financial services haven’t been wildly disrupted over the past 40 years?
DAMODARAN: Has it, though? I mean, has it —
RITHOLTZ: Well, trades are free.
DAMODARAN: Yeah.
RITHOLTZ: You could buy the entire market for three bips. That seems to be enormously disruptive. I could venue (ph) your money without anybody in between us on my phone. I used to think of who said, the only innovation has been the ATM? What was that Greenspan or Volcker?
DAMODARAN: Yeah.
RITHOLTZ: I think that you can do stuff today that was either time consuming or expensive, or not even available 50 years ago, 20 years ago.
DAMODARAN: The customer side?
RITHOLTZ: Yes.
DAMODARAN: Right. And here’s my question, so why does JPMorgan Chase, every time I get a wire, still take $15 off that wire? This is my problem, right? Banks —
RITHOLTZ: You can ACH for free, but it will be 12 to 24 hours later.
DAMODARAN: Yeah. But when I get a wire from outside —
RITHOLTZ: Right.
DAMODARAN: — I can’t tell them what to do. So they take their bank and they wire money to JPMorgan Chase.
RITHOLTZ: Wait. You get a ping (ph) when a wire comes in, not outgoing?
DAMODARAN: I get hit both ways.
RITHOLTZ: Oh, I didn’t realize that. That’s not right.
DAMODARAN: So maybe when I deliver money to others, I can get around the bank. When money comes to me, I have no control over the process. So let’s say I’m getting $5,000. This is what I see from JPMorgan Chase. I see $4,975 put into my account —
RITHOLTZ: Right.
DAMODARAN: — and a wire service fee of $25. What? You know, this is what I mean about the about these businesses acting like it’s 1985 still. Take the publishing business —
RITHOLTZ: Okay.
DAMODARAN: — and I’ll give you an example. One of my publishers, I won’t name them, called me last year and they said because my books have an —
RITHOLTZ: Multiple editions, you have a —
DAMODARAN: multiple editions and I have an Indian edition which is printed on cheaper paper and priced at one-fifth the price because —
RITHOLTZ: Right.
DAMODARAN: –Indians can’t afford to pay —
RITHOLTZ: Right.
DAMODARAN: — the equivalent of $100. And India is the largest market for me outside the U.S. because it’s a big English-speaking population, lots of students. So I get a call from a publisher and they said, well, we’ve decided to suspend your Indian edition, and I said, why?
RITHOLTZ: Why?
DAMODARAN: They said, there’s cannibalization going on. And I said, what are you talking about?
RITHOLTZ: What? Are people in the U.S. buying the Indian edition?
DAMODARAN: They said there are some people in the U.S. who are buying the Indian edition?
RITHOLTZ: How many people?
DAMODARAN: And I said, okay, how many? And they said, we don’t know. But we do know there’s cannibalization going on. I said, let me get this straight. You’re suspending the printing of an Indian edition. This is the largest market outside, this is going to be tens of millions of books because you think there’s cannibalization, but you don’t know how much cannibalization there is? They said, I guess the way you put it that way, that’s exactly what we’re doing. And I said, do you realize this makes absolutely —
RITHOLTZ: Right.
DAMODARAN: — no sense?
RITHOLTZ: You would have to put some flesh on those bones, some numbers, to determine is it still profitable to do this or not?
DAMODARAN: And I said, do you think the cannibalization is going to stop just because you did this? Because you know exactly what’s going to happen, Indians are not going to pay $100 a book. Some person in India or China is going to buy one of the U.S. books. They’re going to —
RITHOLTZ: Reprint it.
DAMODARAN: — copy every page.
RITHOLTZ: Right.
DAMODARAN: They’re going to pirate the book. Now, there are people who bought my book for $2 outside the train station in India because they get the pirated version.
RITHOLTZ: Right.
DAMODARAN: And I said, would you rather cannibalize yourself and get a reasonable price, or would you rather have this Chinese, you know —
RITHOLTZ: The pirated version.
DAMODARAN: — the pirated version cannibalize you and get nothing for it? But that didn’t change the decision. And this is the nature of how decision-making is at universities, publishing and banks, is still the decision-making is driven by a world that’s no longer —
RITHOLTZ: Right.
DAMODARAN: — out there. But it’s very difficult to create change. And this is the old Clayton Christensen argument for why institutions have trouble. The status quo’s trouble with disruption is you have too many legacy effects. It’s almost you can see the person at JPMorgan Chase saying, you should stop charging for these wires because people are going to use alternate ways —
RITHOLTZ: Right.
DAMODARAN: — transferring money. And somebody says, but we make $150 million from the wires. We can’t do that. And that’s a legacy effect affecting, so guess what happens? You essentially take your softest businesses and they get disrupted. I mean, let’s face it, most fintech companies should not exist because they’re either solving problems that are not problems in the first place, or they’re doing regulatory arbitrage. They’re bypassing what would normally be regulated, or they’re taking advantage of inertia, which is banks charging $25, let’s create a Venmo, you know.
RITHOLTZ: Right.
DAMODARAN: And essentially, that’s exactly why I think the status quo institutions are not going to be able to partake in the disruption that’s coming, is they can see it coming. They will say all the right things. But within the organization, there’s such stickiness and inertia, that their decisions are still driven by the way things used to be, not the way things are right now.
RITHOLTZ: And so funny you said that. One of my colleagues, Ben Carlson, and I’m going to paraphrase him, uses the phrase, experts or people who have an expertise in the way the world used to be. And so when things change, and now this is me speaking, there is a void of experts, and all sorts of things rushing to fill that vacuum. And so, that’s how you end up with a crazy run up in crypto because self-proclaimed experts say, no, no, here’s the change.
But the fascinating thing about banks versus other companies, it’s very difficult for a company to disrupt itself. And I have a vivid recollection of seeing Apple do this with the first iPod and got smaller and faster and cheaper and larger capacity. And you could just imagine that conversation, hey, you know, we’re cannibalizing ourselves.
DAMODARAN: Yeah.
RITHOLTZ: And someone must have said, better that we do it than somebody else.
DAMODARAN: Yeah.
RITHOLTZ: Why is that so hard to do?
DAMODARAN: Well, you know, I’m glad you brought up Apple because I think of all the things Steve Jobs did that made the kind of rebirth of Apple possible, the first was on the original iTunes disruption, he told the team, and this is, I think, well documented, act like you’re a startup. Don’t worry about legacy effects. Don’t worry about what the rest of the company thinks because they’re still thinking our business is computers and —
RITHOLTZ: Right.
DAMODARAN: Because you can almost see the discussion with Apple, why are we wasting our time on this distraction? We should be building a better Mac, and trying to get back into the PC business. You know, Steve Jobs saw the writing on the wall that the PC business was not going to be the future, that if you fought Microsoft and the PC business, you’d have the same result you had in the —
RITHOLTZ: Right.
DAMODARAN: — previous decade. You’re going to continue to lose. But he gave the team the freedom to make decisions, but he built on the strengths of Apple at the same time. He said, don’t be a startup act that’s a stranger to the company, draw on the resources of the company, but make decisions as if you’re a startup. Satya Nadella did the same thing at Microsoft, when he came in because this was a company with two hits, Office and Windows, that had never done another thing in their entire corporate life that —
RITHOLTZ: Right. Well, the Zune. To be fair, the Zune was their iPod and —
DAMODARAN: But it never made — none of the stuff —
RITHOLTZ: It went nowhere.
DAMODARAN: — made money, never stopped. And when he entered the cloud business, first thing he did was he said, we’re not going to acquire our way into this business. That’s not the way to grow because we’re going to —
RITHOLTZ: We’re going to build.
DAMODARAN: — be throwing a lot of money in there, and we’re going to build it because we have some strengths. We have people who know software really well. We’re going to take those strengths. We’re going to be patient, and we’re going to act like this is again a standalone business. Don’t worry about the effect on Office and Windows of what you’re doing.
RITHOLTZ: Right.
DAMODARAN: So in my book, “The Corporate Lifecycle,” one of the things I talk about is companies that go through reboots. It’s really difficult to do. And I talk about what they share in common, and one of the things I see is; A, there’s willingness to be patient and build on internal strengths rather than be in a hurry and do an acquisition to enter business. But even within Microsoft, this is the reason I’m less optimistic about Activision doing well for Microsoft, as I was about Microsoft’s original cloud entry.
RITHOLTZ: What about before cloud, what about Xbox, are you saying Xbox never made any money?
DAMODARAN: Xbox never made any money.
RITHOLTZ: Really? I mean, it’s ubiquitous that they gave Sony PlayStation a run for its money.
DAMODARAN: Take Google, right? It’s called itself Alphabet. I think of it as Snow White and the seven dwarfs because 90-percent-plus of its revenue still comes from the search box, right?
RITHOLTZ: So we’re going to come back to that because I want to talk more about life cycle in a few minutes. I want to come back to one last thing about college and education, and it’s the big question that I’m sure a lot of people have been asking, which is we talk about costs. We talk about value proposition of higher education. From your perspective, is the modern college education, as it exists today, is that still a decent value proposition for all students or only some students?
DAMODARAN: It’s a subset, right? I mean, I think if you think about it as an economic proposition, it probably doesn’t make sense for 95 percent of people to go —
RITHOLTZ: That much, 95.
DAMODARAN: — for master’s degrees.
RITHOLTZ: Right. What about undergraduate?
DAMODARAN: Undergraduate, about half the people in my class probably don’t need that degree to kind of let you know.
RITHOLTZ: Really?
DAMODARAN: So I think, in a sense, you know, college education, we overestimate the impact it’s going to have on our future earnings. Even at the very best colleges, you go to Yale, it does help you on that first job. But three or four years in, when they look at the differences across people, the differences in income, you know, the relationship to college you went to starts to disappear.
So if you ask me, can I educate myself today? We have the resources to do it. I mean, you need to find the right player (ph). You can’t just take classes randomly. You can educate yourself. That’s something we could not have done 30 years ago. That option exists for people who are self-starters. But that’s where the discipline part comes in.
So maybe the startup you need an education is a startup that wakes you up at 7:30 in the morning and reminds you that it’s almost like you need that — because the reason you go to college is your roommate wakes up to go to college. He notices you’re still sleeping, and that you have a class at 10:00, and he nudges you saying, aren’t you going to class? You might not wake up, but you’d feel guilty about going back to sleep because your roommate reminded you.
If you can get that discipline component into this process, then I think online education can do just as good a job as a college education, and you can create your networks. You can create your networks. They don’t have to be college networks. I don’t think that the healthiest networks in the world to begin with —
RITHOLTZ: Right.
DAMODARAN: — is the fraternity you belong to.
RITHOLTZ: Right.
DAMODARAN: Those might not be the best connections you have. It takes more work. We’re still not quite there. I mean, I’ll make it personal, one of my kids said, should I go to college? I’d probably still encourage them to do it. I’d encourage them to go to college on a scholarship if they could, and then pick a lesser college. And the college they get into, that they might be the top pick.
RITHOLTZ: Really?
DAMODARAN: Because I think that paying $225,000 or $250,000 for a four-year university education, even if it’s at a very top university, I can’t see the payoff from that economically. Now, I’d much rather that you went to a lesser school, spent the four years there, created and have, you know, all the other stuff that comes to the pack, that college football that you go to —
RITHOLTZ: Right.
DAMODARAN: — and drinking out with friends, and pay $50,000 instead of $250,000. Because think of what that extra $200,000 can do for you with the rest of your life. So, now, I think that might be the place to start, is rather than talking people away from a college education, ask why are you spending so much? Is there a way you can bring it down? And the suggestion you made of these hybrid models, that might be well worth considering as an alternative to going to a four-year university and paying for every single year.
RITHOLTZ: Well, arguably, senior writers, that fourth year, perhaps, if you’re going to give something up —
DAMODARAN: Yeah.
RITHOLTZ: — you get rid of that early on.
(COMMERCIAL BREAK)
RITHOLTZ: Let’s talk a little bit about the corporate life cycle and valuations, but I want to start with a little bit of twist. This was a very short life cycle. I actually thought of you when the whole meme stock, GameStop, AMC, Hertz blew up, and I just imagined what you were thinking, here we go again. What was that period like in 2020 and ‘21? And what were your thoughts about what was going on?
DAMODARAN: You know, when GameStop took off, I know it went from $20 to $400. It obviously caught my attention because if you think about it —
RITHOLTZ: $20 was $3 or $4.
DAMODARAN: It’s $3 or $4. They’re short sellers. Basically, it seemed on a pathway to zero. It seemed like that was going to be the endgame.
RITHOLTZ: Right.
DAMODARAN: And then all of a sudden, you had this group on Reddit —
RITHOLTZ: Reddit.
DAMODARAN: — and Wall Street bets. And then, of course, you had the pushup, you know, that they collectively did. I call this the first crowd short in history, right? I’m sorry, crowd short squeeze —
RITHOLTZ: Squeeze.
DAMODARAN: — in history. Because, historically, short squeezes come from rich people deciding to squeeze other rich people, right?
RITHOLTZ: Right.
DAMODARAN: I mean, that’s basically how it happens. Here, the collection of people. So it’s very much a 21st century phenomenon. In fact, it’s a phenomenon that’s a social media phenomenon because if you think about 20 years ago, you couldn’t even have gathered together this many people —
RITHOLTZ: Right.
DAMODARAN: — in the town square. So when that happened, as you know, part of me said, this has happened before so I’m not going to get extra hot under the collar because of it. Clearly, this has nothing to do with value. It’s got to do with mood and momentum, but that’s not new. Markets have always been driven by mood and momentum. But what social media has done, and this I think is a more general point I would make, is it’s made mood and momentum stronger, right, because you were able to gather together a crowd, a much larger audience.
You know, I remember reading this book, Extraordinary — you might have read the book “Popular Delusions.”
RITHOLTZ: Sure.
DAMODARAN: The crowd by —
RITHOLTZ: Charles Kindleberger?
DAMODARAN: — Charles Mackay. You know Charles Mackay.
RITHOLTZ: Oh, Charles. Okay.
DAMODARAN: And he talked about how in the South Sea bubbles, you know, you created new stories. You went to a pub, you acted like you were drunk, and then you blurted out what you said were secrets about South Sea that nobody should know. And then other people in the pub heard you and they went and bought the shares. And I thought —
RITHOLTZ: The original social media.
DAMODARAN: And I originally wrote about it, when I wrote about CNBC 30 years ago or 20 years ago, I said, this is today’s pub, which is you go on CNBC, you say look, I’m going to tell you a secret just between you and I —
RITHOLTZ: Just you, me and the company.
DAMODARAN: — about the company.
RITHOLTZ: Right.
DAMODARAN: But if you think about social media, that now has become the place you go. You go to —
RITHOLTZ: So you said mood, momentum, and there’s —
DAMODARAN: Action (ph), right?
RITHOLTZ: There’s narrative there also —
DAMODARAN: Yeah. There’s a story.
RITHOLTZ: –because all these things are stories.
DAMODARAN: At the core, there’s usually a story that makes sense. Even the stupidest pushups are driven by a core story that has some truth to it.
RITHOLTZ: Loosely based and whatever.
DAMODARAN: For instance, you could argue that GameStop has potential in the online gaming market.
RITHOLTZ: Right.
DAMODARAN: They have a collection of data of people who have shopped at the store —
RITHOLTZ: Right.
DAMODARAN: — that they’re going to build on it and that will —
RITHOLTZ: Then a new guy comes in who’s done this with an online Chewy.
DAMODARAN: Exactly. So —
RITHOLTZ: And that worked out well.
DAMODARAN: And that, in fact, one of the things you find at the core is there’s a core story that is true. You’ve just come up with a number that has completely no relationship —
RITHOLTZ: Right,
DAMODARAN: — with the magnitude of that story. So it’s something that has happened before. But what it shows you with social media, how much what might have been a 20 percent bubble can become a 100 percent bubble in the social media age. And so it was actually interesting watching it play out. I actually went to the Reddit site because I wanted to see what rationale people were giving each other for buying the shares. You know —
RITHOLTZ: And for people who don’t play on Reddit —
DAMODARAN: Yeah.
RITHOLTZ: — you register at Reddit, you can upvote or downvote stories.
DAMODARAN: Exactly.
RITHOLTZ: And so, all these things bubble up to the top —
DAMODARAN: Right.
RITHOLTZ: — where the crowd is enthusiastic about it. It’s very much bubblicious.
DAMODARAN: Okay. So the question I was asking was, what is the core reason or the driver of this? And it seemed to be revenge. Revenge in what sense? The core reason people were giving for buying GameStop had nothing to do with GameStop. It’s because they wanted to get back at the hedge funds. That was it. We’re going to bring the hedge funds down, which is interesting because some of the biggest hedge funds were making money from this.
RITHOLTZ: Right.
DAMODARAN: We’re on the other side of the fence then.
RITHOLTZ: Payment for order flow.
DAMODARAN: Yeah.
RITHOLTZ: The more you trade, the better they do.
DAMODARAN: It’s a human emotion, revenge, and here you have a collection of people saying we’re going to take revenge by pushing up the price of GameStop and drive. And you still see this phenomenon. AMC, you’re seeing the phenomenon.
RITHOLTZ: Right.
DAMODARAN: Bed Bath & Beyond, you saw the phenomenon. This is something that seems to play out, and it’s usually younger people who have an emotional connection. If you look at the big companies that are in the meme phase, you know, you see GameStop. You see AMC. You see Bed Bath & Beyond. It’s almost like you can see 35-year-olds with nostalgia for the malls they used to visit 15 years ago, and we’re going to save this piece of our past. So it’s interesting.
There is a collection of things coming together in the meme stock phenomenon. But it’s an old phenomenon that’s replaying out there. So I won’t blame the investors — the traders, let’s not use the word investors, the traders —
RITHOLTZ: Right.
DAMODARAN: — in the stocks for doing something that is irrational. I think it’s just reflects humanity and it’s always going to be with us.
RITHOLTZ: So now let’s talk a little bit about some life cycle stocks, some companies that seem to have really gotten shellacked over the past couple of years. I’m curious as to your perspective. One of the things I noticed, so Amazon had a terrible 2022 as did a number of other companies. But a lot of people don’t realize 2021, when S&P was up 28 percent, Amazon was flat up a percent or 2. What’s going on with Amazon in their life cycle? Why do they suddenly seem to have lost their mojo?
DAMODARAN: I think that if you think about pricing, it’s driven by mood and momentum, come easy, go easy. And I think, in a sense, to complete the story, you need to bring in what happened in 2009, in fact, the previous decade to these FAANG stocks —
RITHOLTZ: Which was amazing.
DAMODARAN: — which was amazing. One out of every $6 in increase in value that came to market, increase in market cap during the last decade happened in just six companies.
RITHOLTZ: Like 16 percent. That’s something.
DAMODARAN: Sixteen percent, $1 in $6. Those six companies accounted for 16 percent of the increase in market cap of 7,500 U.S. stocks.
RITHOLTZ: Wow.
DAMODARAN: The implication of that is if you spent the entire decade with none of the stocks in your portfolio, I don’t see any way in which you could have created any kind of positive alpha, right?
RITHOLTZ: Right.
DAMODARAN: It’s almost like you had to have at least one, hopefully more than one. So you’re coming off a decade where you’ve added trillions of dollars in market cap, often based on flimsy stories that you don’t carry through. Netflix, we can keep adding subscribers. Nobody seemed to ask the question, you’re going to run out of people on the face of the earth before you add subscribers.
RITHOLTZ: Or get competitors on top of that.
DAMODARAN: Or get competitors on top of it. So in a sense, the last two years, I don’t think of as a big drop-off in value to return to some degree of sanity.
RITHOLTZ: Now, some companies, like Apple and Microsoft, seemed to have held up much better than Tesla, Netflix. I’ll leave out the pelotons —
DAMODARAN: Yeah.
RITHOLTZ: — and the purely lockdown stocks. But Amazon had a great run, Bezos retires.
DAMODARAN: Right.
RITHOLTZ: And personally, I’m a giant Amazon user since my college roommate —
DAMODARAN: Right.
RITHOLTZ: — gave me a gift certificate sometime in the ‘90s. And now, I’m very comfortable putting my credit card elsewhere. Hey, what’s the worst you can do? You lose $50.
DAMODARAN: Right.
RITHOLTZ: And the site, you search for something on Amazon, the first five results are ads. It’s festooned with garbage. It was once the go-to site. And now, it’s like constantly disappointing. Is that just my subjective view, or is Amazon now at the point in their life cycle where delighting the customer is no longer their priority?
DAMODARAN: I think they took their eye off the ball. I mean, let’s face it, Amazon started as a retail company. They built a reputation as an online retail company. About 10 years ago, when I valued Amazon, I described it as a disruption platform. In other words, I said, this is no longer a company that thinks of retail as its core business.
RITHOLTZ: Right.
DAMODARAN: It’s going to disrupt any company in any business, if it feels there are soft spots. And in a sense, you’ve seen Amazon’s actions over the decade reflect that.
RITHOLTZ: So cloud —
DAMODARAN: Cloud.
RITHOLTZ: — advertising, search, what else is Amazon doing well outside of retail?
DAMODARAN: Well, logistics.
RITHOLTZ: Right.
DAMODARAN: So in a sense, they’re bringing in businesses that you might have viewed as also —
RITHOLTZ: Online payments.
DAMODARAN: Yeah, online payments.
RITHOLTZ: They outsource Azure.
DAMODARAN: You know, healthcare, they have little experiments that they’re running. So —
RITHOLTZ: Right.
DAMODARAN: — the only problem is when you’re looking at that many different businesses, it’s difficult to keep focus. And I think that you see this with the Alexa write-offs. They’re taking widgets (ph).
RITHOLTZ: Right.
DAMODARAN: What exactly was the endgame with Alexa? What were you trying to do? I was never quite clear on what Alexa was supposed to do.
RITHOLTZ: We want to be in the forefront of voice as an input device.
DAMODARAN: Right. But then how do you make —
RITHOLTZ: Who knows?
DAMODARAN: So what is the revenue base, which is a weakness in many tech, that Amazon did not use to have. I used to describe Amazon as a company that run for revenues first, but it always had designed long term, this is what we want to do. And some of the stuff they’ve done over the last few years, I’m not sure what their endgame is, other than, hey, we’ll have more people in our ecosystem.
RITHOLTZ: Right.
DAMODARAN: So I think that Amazon took their eye off the ball. And you’re right, their retail side has become just — you know, there’s a lot of chaos going on that I don’t trust Amazon reviews anymore because we know —
RITHOLTZ: Well, any review online is garbage.
DAMODARAN: Because basically the reviews —
RITHOLTZ: They’re all bought. They’re all bots (ph).
DAMODARAN: Exactly.
RITHOLTZ: Yeah. They’re all terrible.
DAMODARAN: So I think Amazon needs to return to that core business and kind of make sure that it’s cleaned up to get back the customers. But they still have that disruption army, right, Amazon Prime. And I think that they need to make sure that they’re not putting the loyalty of those Prime members to the test —
RITHOLTZ: By getting close.
DAMODARAN: And I think they need to be care — I think that’s part of what the markets doing is sending them a warning. Let’s see if they listen.
RITHOLTZ: So let’s talk about Google. When the first time I use Google, I want to say it was 2001 or 2002, when it was just so simple. Nothing was close. It absolutely dominated. The results were great. It was Google. No one is even second or third, everybody else. And they completely appended the search market. You go to Google Search now and it’s junk.
DAMODARAN: Yeah.
RITHOLTZ: Like, your first five results are garbage. They try and send you to Google Properties. Like, they are ripe for someone to come along with the equivalent of PageRank and put that — I still like Google Calendar and Google Drive, and —
DAMODARAN: None of which they make money on.
RITHOLTZ: Right. Gmail, all this stuff they do that keeps you in their —
DAMODARAN: Ecosystem.
RITHOLTZ: — ecosystem. But let’s be honest, Google Search is completely polluted. It’s garbage. There are a handful of nonprofit competitors —
DAMODARAN: Right.
RITHOLTZ: — that do a much better job. Again, are all these companies, inevitably, we’re going to eat our seed corn, we’re going to over-monetize our core customers?
DAMODARAN: Right.
RITHOLTZ: So Microsoft hasn’t really done that. Apple hasn’t really done that. Although to be fair, I’m a longtime Mac user. And Apple, you know, they nickel and dime you for everything —
DAMODARAN: Yeah.
RITHOLTZ: — from quartz to this, to that. It hasn’t boomeranged on them. Facebook, another company that seemed to have blown itself up.
DAMODARAN: You know, I think it’s almost built in every company’s DNA, that they will blow themselves up. It’s a nature. That’s why —
RITHOLTZ: Life cycle.
DAMODARAN: — you use the term life cycle —
RITHOLTZ: Sure.
DAMODARAN: — which is, as you age, you look back with nostalgia at what you used to be able to do when you’re 25. And then you make the stupid mistake of thinking that if you spend enough money, you can go back to being 25.
RITHOLTZ: It doesn’t work that way.
DAMODARAN: You know, you can try paying a plastic surgeon to get a — but gravity works its magic anyway. And companies do the same thing, which is the constantly trying to rediscover their youth. But, eventually, you get middle aged.
RITHOLTZ: Right.
DAMODARAN: Facebook, Google, Apple, that entire group of companies are middle-aged companies. I mean, that’s not bad. They’ve had a great younger life. But they have to recognize if you’re middle-aged, you don’t overreach. You don’t jump out of bed. You very gingerly step out of bed because you jump out of bed, 23, you were okay. You land on your feet. You jump out of bed and you’re 55, who knows where you will land, right?
RITHOLTZ: Right.
DAMODARAN: So I think one of the points I’ve always made, these companies need to act their age. Apple and Microsoft have tended to act their age, which is —
RITHOLTZ: They seem to have adapted to being mature companies.
DAMODARAN: To being adept. Yeah.
RITHOLTZ: And they know what their limitations are.
DAMODARAN: It maybe pure coincidence, but they’re the oldest companies in this group. They’ve lived through pain before.
RITHOLTZ: Multiple cycles.
DAMODARAN: Right?
RITHOLTZ: Yeah.
DAMODARAN: Apple has lived with a near-death experience. Microsoft has seen what happens when your existing projects age. So in a sense, they’ve learned the lessons from this saying, we need to be more careful about how we behave because we’re older companies. Google and Facebook are young companies in terms of chronological age. The people running Google, it’s not some distant memory, they remember when they were at peak age, right?
2017, you looked at Google and Facebook, I remember being in a discussion with my friend, Scott Galloway and he said, we got to break up these companies. They’re going to dominate the world. And I said, Scott, you don’t have to break them up. They will do it themselves.
RITHOLTZ: Right.
DAMODARAN: They will overreach. It’s going to be much more effective than any regulator doing it. So your pathway to fit in — because he’s worried about Facebook taking over the world. I said, don’t worry, it will eventually — and this has been the case with technology companies especially, they will overreach and that overreach will be what brings them back to it.
RITHOLTZ: When Galloway and I talked about the four, one of the questions we discussed was, of the four, which do you think is most likely to stumble first? And I thought it was obvious that Facebook was part of a much shorter cycle.
DAMODARAN: Right.
RITHOLTZ: We’ve gone through Friendster and MySpace and Facebook —
DAMODARAN: Yeah.
RITHOLTZ: — and now Twitter and Instagram and TikTok. They got very lucky with some great acquisitions.
DAMODARAN: Right.
RITHOLTZ: But it was pretty clear that Microsoft and Apple both learned how to adopt. One of the interesting things I wanted to ask you about those two companies, each of those companies had a bit of a crisis, obviously, much worse at Apple, if you remember the famous Wired cover, Pray —
DAMODARAN: Yeah.
RITHOLTZ: — with the crown of thorns around the apple. But in each case, a new CEO, first, the return of Steve Jobs replaced the floundering CEO, and the same thing with Satya Nadella replacing Steve Ballmer, who really seem to have lost the thread. How important is it for a mature company to have a mature CEO to come in and maximize their assets? That’s not age inappropriate. That’s not the 55-year-old wearing the kids clothes and looking completely — we call it AI age inappropriate.
DAMODARAN: I mean, I think you’re raising a very interesting and a big point about corporate governance and how we change management. I mean, one of the chapters in my book is about who’s the right CEO for your company. Because if you listen to McKinsey and Harvard Business Review, they claim they have 23 characteristics.
RITHOLTZ: Right.
DAMODARAN: That’s not true. The right CEO of a company will depend on where you are in the life cycle.
RITHOLTZ: Right.
DAMODARAN: If you’re a startup, you want a storyteller. You want a visionary. Why? Because you got to get people to buy into your story, your employees, your investors, your customers.
RITHOLTZ: Right.
DAMODARAN: Let’s call that person Steve, the visionary. Then you get to this phase where you’re building a business. Now, you’ve gone from vision, you need somebody pragmatic because if you’re a visionary who says, I want this perfectly the way my vision tells me, you’re never going to get off the ground.
RITHOLTZ: Right.
DAMODARAN: You need a builder. Let’s call Bob, the builder or Brianna, the builder, if you want to stop being sexy and make the CEO somebody of the other sex. Then you get to this phase where you get to be a mature company. You need Dawn, the defender, somebody who’s most protecting your core business because if you take your eye off that and you go after new businesses, somebody is going to eat your core business.
And then you get to the last phases. You know who you need running the company, Larry, the liquidator. I see Danny DeVito every time I see Bed Bath & Beyond, right? You need somebody coming and saying, there is no good ending to the story.
RITHOLTZ: Right.
DAMODARAN: You can hire the best CEO in the world. There’s no turn around here.
RITHOLTZ: Once you get to the 18th hole, it’s over.
DAMODARAN: And here’s the big reason why I think this is going to become a bigger issue in the 21st century. In the 20th century, let’s take Ford, right. Henry Ford was the perfect CEO for Ford as a startup. Why? He had a vision. Visionaries are strange people. They’re eccentric. So he made the Model T only in one color. Why? Because that’s the way he wanted everybody to drive. Everybody drives a black car. Why would you want a different color?
But by the 1930s, he was actually developing other tastes which were not particularly appropriate for U.S. automobile company. But time took care of the problem. He passed on, and now his grandson took over. Time to care of these transitions because the typical company in the 20th century took 40 years to build up state, 40 years at the top, and then declined over 30 years, a 100-year life cycle. In contrast, think about a Yahoo or a Blackberry. From start to end, you’re looking at 15 to 20 years.
RITHOLTZ: So the life cycle had been rapidly decelerating.
DAMODARAN: Which means that the person running the company as a mature company is often the same person who has the company, who created the visionary, who started the company, is now running the company. And let’s face it, now, the guys in BlackBerry were great with vision. They were terrible managers. They were awful at making decisions as a mature company, but they were still making the decisions. And guess what, the decision they made drove the company into the ground.
RITHOLTZ: Right.
DAMODARAN: And I think that’s going to be an increasing problem in the 21st century because the 21st century company ages in dog years.
RITHOLTZ: Right. Much faster. So let me bring up another company.
DAMODARAN: Yeah.
RITHOLTZ: We started hinting about, when we were talking about Twitter.
DAMODARAN: Yeah.
RITHOLTZ: So I give Tesla and Elon Musk huge credit. I think the automobile industry looked at what he was building with Tesla, and then off in their peripheral vision, so what Bezos had done, destroying every industry he touched. Your profit margin is my opportunity.
DAMODARAN: Yeah.
RITHOLTZ: And they said, we better get on the ball with this. If we move to a fully electrified future, whether it’s five years from now or 10 years from now, at least in transportation, he gets full credit. But it seems like between Tesla and then SpaceX, and then The Boring Company, and then Twitter, what’s going on with the life cycle of Tesla? Even though, by the way, we’re recording this at the end of the first quarter in 2023, the stock has done very well this year. Ballpark, it’s doubled from its lows in 2023.
DAMODARAN: The other extreme, you have people who are convinced that this company is a scam. Now, they’ve always believed it’s a scam.
RITHOLTZ: Really? A scam? I mean, they’re selling a lot of cars.
DAMODARAN: And they claim the whole thing is accounting, you know, game playing, that the company has never made money. There’s a whole Tesla short community might visit.
RITHOLTZ: Right.
DAMODARAN: They think this whole thing is going to — it’s just a pack. The whole thing is going to come crashing down, which means that unwilling to listen to any story you tell about, hey, you can’t dismiss this company. As you said, it’s changed the entire business, the automobile business —
RITHOLTZ: Right.
DAMODARAN: — a business that was immune to change. And think of DeLorean trying to do —
RITHOLTZ: Sure.
DAMODARAN: — 30 years ago, right? It destroyed every person trying to change the business. And in 10 years, Elon Musk has done more for climate change than all the ESG people put on the face of the earth —
RITHOLTZ: Right.
DAMODARAN: — because he’s changed how decisions are made in the business. And I’ve tried to navigate that middle ground by saying this company is not as amazing as you think it is to the Tesla fans. And at the same time, there’s something special —
RITHOLTZ: Right.
DAMODARAN: — about this company you need to bring it in. I think that the problem with the company, and this is something I would say about any company, I’d say it’s a company that is wrapped up in a person.
RITHOLTZ: Right.
DAMODARAN: And what I mean by that is when you think Tesla, you think Elon Musk. There’s, you know, further —
RITHOLTZ: Now, Apple had that issue in the early 2000s with Steve Jobs. And the transition to Tim Cook seems to have gotten much better than anyone was forecasting.
DAMODARAN: But it took a while. Remember that after Tim Cook came in, people said, you’re not doing what Steve Jobs would have done. Why aren’t you disrupting a new business? Tim Cook was a business builder. In a sense, he said —
RITHOLTZ: Right. He’s a logistics guy.
DAMODARAN: And he said, look, we’re a trillion-dollar company. We can’t be going after new businesses and not protecting the core business.
RITHOLTZ: Right.
DAMODARAN: I might be saying something that’d be sacrilegious. But in a sense, I think Apple is better off with Tim Cook having run it for the last decade.
RITHOLTZ: He is the right person for that phase of the life cycle.
DAMODARAN: Then if Steve Jobs had stayed on because Steve Jobs would probably have shot for the moon on something else and ended up effectively putting a trillion and a half dollars at risk. So I think that you need transitions. But, unfortunately, we’re also creating a structure, where doing that has become more difficult at some of these companies that are the 21st century companies.
And what I mean by that is if you don’t like the way Mark Zuckerberg likes Facebook, he owns only 14 percent the stock.
RITHOLTZ: But?
DAMODARAN: But because we allowed, we collectively and we have to take the blame for this, we as portfolio managers and investors allowed Facebook to go public, with two classes of shares —
RITHOLTZ: Right.
DAMODARAN: — we’ve effectively given Mark Zuckerberg 57 percent of the voting rights in perpetuity. And when this happened, I remember asking this question to portfolio managers, why are you okay giving up this much power? And their response was, he’s a genius. He’s amazing.
RITHOLTZ: And he certainly looked like one for the first couple of years of them being public.
DAMODARAN: And the response I had was, you know what happens to benevolent dictatorships over time is what starts as a benevolent dictatorship eventually becomes malevolent, and you’ve taken away the power to do it. And they said, don’t worry about it. That will never happen.
RITHOLTZ: So let’s talk about some of the other benevolent dictatorships that had a similar super voting structure. Uber was set up that way. WeWork was set up that way. I think — was Theranos also a super — I believe they —
DAMODARAN: They never got quite to that stage.
RITHOLTZ: But it was heading in that direction.
DAMODARAN: Even Elizabeth Holmes’ personality —
RITHOLTZ: Yeah.
DAMODARAN: — it probably would have super voting right.
RITHOLTZ: So have we now gotten to the point where this sort of silliness is over, or are the venture capitalists and investment banks that bring these companies public, are they still playing that game?
DAMODARAN: I wish I could tell you that markets have a good sense to learn and adapt, but I don’t think they do. What strikes me as amazing in markets is how much collective amnesia there is. So three months of Facebook going up, and all of a sudden, they’re forgotten all the complaints —
RITHOLTZ: Right.
DAMODARAN: — they had at Facebook’s bottom. So I wish I could tell you that investors and portfolio managers would have the stomach to stand up and say, you know what, we’re not going to take these two classes of shares anymore. But I think once we opened the door, and I blame Google for this, Google in its eyes —
RITHOLTZ: Right.
DAMODARAN: — created this process.
RITHOLTZ: Yup.
DAMODARAN: And people who walked in, it’s very difficult to relock that door. And so I wish, you know, that change would come back, but I’m not optimistic that it will.
RITHOLTZ: So now is a good as time as any to talk about ESG, and let’s start with the G being governance. How can anybody in good faith own these companies if one of your deciding factors is we want to see good governance at the companies we own?
DAMODARAN: I’m going to say something about the G in ESG, right. The governance in ESG is not the corporate governance that we’ve talked about in finance for 50 years, which is managers being accountable to the owners of a company.
RITHOLTZ: Right.
DAMODARAN: That’s corporate governance that I was brought up and all the research in it. The G in ESG is stakeholder governance. You’re accountable to everybody. You’re accountable to shareholders. You’re accountable to lenders. You’re accountable to society. You’re accountable to, you know —
RITHOLTZ: Does that make you accountable to nobody?
DAMODARAN: Exactly. Because you then have a reason — with each group, you claim the other groups are the reason you underperform.
RITHOLTZ: Right.
DAMODARAN: So when I look at the G in ESG, I have the same reaction I had and I’m old enough to remember when there were two Germanys —
RITHOLTZ: Right.
DAMODARAN: — West Germany and East Germany. I remember what East Germany called this up. Do you remember?
RITHOLTZ: No.
DAMODARAN: It’s called German Democratic Republic.
RITHOLTZ: Oh, okay.
DAMODARAN: There was nothing democratic about it —
RITHOLTZ: Right.
DAMODARAN: — or republic about it. Same reaction when people say People’s Republic of China.
RITHOLTZ: Right.
DAMODARAN: Right? It’s not like people in Beijing suddenly said, what do the people think? And so, really, you pick it because you want people to look at the name and think you are free and democratic. ESG, that choice of G was deliberate. It was to make it look like they cared about corporate governance, when in fact, it’s the exact opposite of everything I think of in governance because it makes managers accountable to no one.
RITHOLTZ: So my naivete about the G in ESG has always been, hey, in the old days, it was a bunch of older white dudes.
DAMODARAN: Yeah.
RITHOLTZ: And that leads to groupthink.
DAMODARAN: Right.
RITHOLTZ: So if we create a little diversity of thought, we bring women onto the board. We bring people of colors onto the board. We have geographic diversity. We have domain expertise diversity. We’ll skip the groupthink and end up with a better decision-making problem.
DAMODARAN: But that’s an empirical question, do we actually do it, right? Are more diverse boards asking more questions? I mean, ultimately, governance here means you have a board of directors that’s active and aggressive about — I would love to see a board of directors stop a CEO from doing an acquisition. That, to me, is governance at play, where the board says, you know what, this acquisition makes no sense. We’re going to put brakes on this process for six months and look at the numbers. We’re not going to let your banker come in and show us synergy numbers and push us through.
RITHOLTZ: Right.
DAMODARAN: We’re going to do our due diligence.
RITHOLTZ: How often does that happen?
DAMODARAN: And I think that there is no evidence that I can see off, that having diversity, by itself, makes boards more effective. Now, I think that what you need is we need to change the process by which we pick the directors on board because to the extent that you have nominating committees and CEOs have input into the process, the nature of the process, you’re going to self-select. I don’t care how diverse the board is, you’re going to self-select people who are less likely to ask you those stuff, governance questions.
RITHOLTZ: What is the alternative? Because the reality is a person who’s not an indexer —
DAMODARAN: Right.
RITHOLTZ: — hey, I’m going to pick a portfolio of a dozen companies and that’s my core. Add 12, 15, it should be enough companies to get the advantage of portfolio diversification. That means I have 6, 8, 10 directors I have to choose on 10 or 15 companies, 90 people I have to figure out. You can’t get people to vote for their own congressperson.
DAMODARAN: Right.
RITHOLTZ: How do you get self-interested investors to put the time in to select 90 board members?
DAMODARAN: I think it’s going to be almost impossible to get that done at the shareholder level because —
RITHOLTZ: So it has to be institutional.
DAMODARAN: It’s got to be institutional. So I think that, unfortunately, this is not a process where you can expect shareholders to do their homework on who’s standing for the board of directors? What’s their background? Do they know the business? I mean, who has the time to do this especially —
RITHOLTZ: Right.
DAMODARAN: We tell investors to diversify. We also tell them to do due diligence. They have lives to live, families to feed. They don’t have the time to do this. So I think it has to be institutional, and I think we need a corporate governance score that’s not based on looks and checkboxes —
RITHOLTZ: Right.
DAMODARAN: — but based on actions. I want to get no votes at board meetings recorded, and I’d like to know the percentage of the time directors vote no. I remember Harold Geneen, who was CEO of ITT. This is a conglomerate in the 1970s.
RITHOLTZ: Right.
DAMODARAN: He said there was that — and he was what I call a corporate Caesar, with complete power. And he said there was not a single action taken by his board where the decision was not unanimous. And my reaction was, that’s a rubber stamp —
RITHOLTZ: Right.
DAMODARAN: — if everything you come up unanimously gets voted on. So maybe we need less focus on how big is the board. In fact, many of the corporate governance scores are based on very surface level things. Are they insiders or outsiders? How big is the board? How diverse? I’d like to get a sense of how effective is the board, how many no votes you get, how much pushback you get on CEOs because that really is a true measure of governance. And we don’t have that now, and I think that might be a measure that could be useful for investors to get a sense of is this an effective board or an ineffective board? You know, because that, as you said, is a useful piece of information to investors.
RITHOLTZ: It’s very hard as a board member, especially on a smaller company, to vote no because these are your peers, your colleagues, and it’s difficult to be — you know, we’re social primates, it’s very difficult to go against the group.
DAMODARAN: And when you throw in an authority figure in there, which is the CEO —
RITHOLTZ: And a lot of money.
DAMODARAN: — who knows far more about the company than they do —
RITHOLTZ: Right.
DAMODARAN: — then it’s natural. It’s psychologically young (ph). So that’s why I think, you know, we lost track of this in corporate governance research. We thought the problem was insiders. So if you look at the Sarbanes-Oxley law, they fixed all the surface level problems, which is you can’t have your cousin on the board.
RITHOLTZ: Right.
DAMODARAN: You can’t have your brother on the board. Those are insiders. You need outsiders. And in a sense, and there’s research that suggested that big boards are less effective than small boards.
RITHOLTZ: Sure.
DAMODARAN: So they said, we’re going to say we’ll have a small board composed of outsiders, and then we added. You know, it’s diverse, more likely to get pushback, and we left it at that. But we did the easy stuff. And that’s the problem with scores is they do the easy stuff. They do the checkbox.
RITHOLTZ: Right.
DAMODARAN: They don’t look at actions which actually change governance. And in fact, you know, extending this, any scoring system is going to create gaming, which is companies are going to figure out what drives the score, and then they’re going to game the system to get a higher score. That’s not because of bad companies. It’s because scoring systems create gaming. And I saw that play out with governance scores.
Now, we were told in 2001 and ‘02, when S&P announced governance scores, this is going to change corporate governance because now we’re going to score companies. Twenty years later, I look back and say it changed nothing. We’ve had voting and non-voting shares.
RITHOLTZ: Right.
DAMODARAN: Governance has actually become more difficult now than 20 years ago, and I think it’s made me a lot more skeptical about scoring systems changing behavior. All they do is create gaming that companies use to make their scores higher without changing anything of consequence.
RITHOLTZ: Quite fascinating. Let’s talk a little bit about the state of valuation today. We’ve seen a lot of factors driving prices, especially the rapid rise in Federal Reserve rates and the big inflation we saw in ‘21 and ‘22. How do you look at the market overall in 2023?
DAMODARAN: I think it’s a market driven by two macro forces. One is inflation, the other is what’s going to happen to the economy. And at the start of this year, I said those are going to dominate the discussion. So now we’ve had this distraction, in a sense, for markets with the banking crisis.
RITHOLTZ: Right.
DAMODARAN: And it’s, in a sense, a side game that’s going on. But, ultimately, what happens in the banking crisis, you could actually argue that it was inflation that created the banking crisis in the first place.
RITHOLTZ: Meaning inflation or the Fed increases?
DAMODARAN: Inflation drives interest rates. In fact, I think one of the most unhealthy things we’ve done over the last decade is we’ve given the Fed powers it never has. The Fed doesn’t set rates.
RITHOLTZ: It’s bond market. Right.
DAMODARAN: It chases rates. The reason rates went up last year, with or without the Fed, is inflation was going up. And once rates went up, you had banks like Silicon Valley Bank which had bonds at low rates, which had to reprice the bond. So inflation is at the core of almost everything we’ve seen in markets for the last year and three months. And it’s always been the case, once inflation gets on stage, it’s a hog. It’s an attention hog. It sucks up everything. So I think right now, inflation is at the core of almost everything you do. Whether you’re a trader or an investor, you have to think about inflation because you have no choice.
RITHOLTZ: Really interesting. Now, if we look at the Fed’s 2 percent inflation target, you have zero interest rates for a decade, so you can’t really blame that. You have the lockdown, the supply chains, the fiscal stimulus, the shortages of labor, semiconductors, houses, cars. It seems to be a lot of moving parts, a very non-traditional type of inflation. How should the Fed be behaving? Let’s go back to March 2021 when CPI ran up through their 2 percent target.
DAMODARAN: Right.
RITHOLTZ: Should they have taken notice then?
DAMODARAN: They probably should have because here’s the problem, and I wrote a piece then saying, you know, even if inflation is purely supply — because initially their claim was this is transitory. It’s going to be very, very short term. And I said, even if that’s true, to the extent that there’s a possibility that it’s not transitory, you need to act now. And the reason I said that is inflation is as much a psychological phenomenon —
RITHOLTZ: Right.
DAMODARAN: — as an economic phenomenon. I mean, I’ll give you an example. The restaurant that I live next to, a Mexican restaurant, the price of a burrito had stayed the same for a decade.
RITHOLTZ: Right. Well, we had a fairly low inflation for a long time.
DAMODARAN: Yeah, low inflation, right? But then he raised prices, and then once he started raising, the score now, every month I go in, the price is up another 10 or 15 cents because he’s being prudent. He’s saying, look, I’m going to raise the prices because I need to pay my employees. They’re going to ask me for higher wages. So once inflation gets embedded in people’s psyche, it starts to affect how people ask for wage increases, how much you raise prices, which means often the only way you can break the back of inflation is to brand the people into hostages. You basically tell people don’t go ask for a pay raise, you might lose your job.
RITHOLTZ: Right.
DAMODARAN: Don’t raise prices because people might not come in, which is an economic recession. The Volcker nightmare that played out, where he said, look, I’m going to break the back of inflation, and he did, but it took a very severe recession —
RITHOLTZ: Right.
DAMODARAN: — because that’s the only way you can break that cycle of higher prices. I think we’re in that cycle, which is one reason inflation is so stuck (ph). It’s so stubborn. It’s not going away quickly. It’s because it’s not just about fixing the supply chains. It’s now in people’s psyches. People are asking for pay raises based upon — we look at the LA school district strike and the pay raises teachers were asking for, it was like 7 percent, 8 percent a year. You know, three years ago, they’ve asked for 3 percent a year.
RITHOLTZ: So let’s address that —
DAMODARAN: Yeah.
RITHOLTZ: — because I sometimes feel that we take things for granted. And don’t see both sides of the problem. In the bottom, I don’t know if you want to call it quartile or bottom half of the wage earners, certainly minimum wage has lagged everything for 30 years. It’s lagged inflation. It’s lagged productivity. It certainly lagged the stock market and executive compensation. Nobody was very upset when wages were deflationary.
DAMODARAN: Right.
RITHOLTZ: But, suddenly, and those of us that aren’t in the bottom half of the wage pool, look at it and say, stroke her chin and say, oh, now this is inflationary. We have to do something about it. It seems like a lot of the —
DAMODARAN: Took off (ph). Yeah.
RITHOLTZ: — burden of fighting inflation —
DAMODARAN: Ends up.
RITHOLTZ: — is landing on the people who can least afford it.
DAMODARAN: That’s exactly the reason you don’t want to let inflation get out of control because the people who pay the price to fight inflation are not the upper middle class and the wealthy. It’s the people at the bar. Because when you have a recession, guess who lose their jobs first? It’s the day to day, you know, hourly worker who said, you’re going to work less hours. I’m going to pay you less. So I think you’re absolutely right. The people that inflation punishes the most are not the wealthy people. They can find places to put their money and earn money to cover inflation. It’s the people who can least afford. That’s why inflation is a hidden tax. It’s the worst possible tax —
RITHOLTZ: Right.
DAMODARAN: Because the people paying it are the people who can least afford to pay it.
RITHOLTZ: So let’s bring this back to equities —
DAMODARAN: Right.
RITHOLTZ: — and valuation. It seemed in ‘20 and ’21, and even in ‘22, lots of companies were able to pass through their input cost increases to the end consumer. And then after a while, it seemed companies that no longer had input costs going up continued to raise prices. First, what does inflation generally do to valuation? And are the greedflation stories accurate, or is that, you know, a little political wrangling?
DAMODARAN: Let me take the second question first. I’ve ever heard that story and it showed up as higher profit margins and higher returns that you’re making.
RITHOLTZ: We’ve been in pretty record high.
DAMODARAN: And the margins have been rising now for a decade partly because the subset of companies with the highest market caps —
RITHOLTZ: Right.
DAMODARAN: — and our technology coming in.
RITHOLTZ: Are very efficient.
DAMODARAN: And a software company can deliver 35 percent margins because of unit economics.
RITHOLTZ: Right.
DAMODARAN: The extra unit of software costs you nothing. So if you clean up for that and you look at ‘21 and ’22. and said did margins go up because that’s the inflationary rise.
RITHOLTZ: Right.
DAMODARAN: I mean, in some sectors, margins obviously continued to creep up, parts of software. But, overall, margins for U.S. companies have been pretty stagnant. So if there’s been price gouging. It’s not showing up as higher profits in the aggregate. That doesn’t mean some companies are not price gouging. But in the aggregate, the story doesn’t hold up.
On the first issue of how does it affect valuation, I think that it boils down to pricing power. If you have pricing power, you can insulate yourself against inflation by passing it through. And there are some companies that clearly have pricing power that have done that, which is one reason equities have been remarkably resilient given what’s happened to interest rates and cost of capital.
2022 was a record year in terms of how much cost of capital of companies went up in one year. The biggest single year increase I’ve seen in the 60-plus years that I have tracked the data for. So I think that equities have been resilient precisely for that reason. They’ve been able to pass the earnings through.
RITHOLTZ: Is it fair to say equities are inflation hedge? Because I’ve heard that my whole career and it never really resonate with it.
DAMODARAN: Not collectively. If you have a subset of companies which are pricing power because it turns out that if you look at equities collectively, that pricing power is not complete. You’re not able to pass inflation through completely. So I think equity neither — no financial asset can be a good investment if inflation is rising, whether it’s stocks or bonds, any kind of financial asset because, collectively, you don’t have enough pricing power to pass it through.
RITHOLTZ: Right. So here we are on the good side, it seems that inflation peaked a couple of quarters ago and have come down, wherever we look lumber, energy prices, copper, going down the list of all the things, even container, shipping containers and things like that have come back to pre-pandemic level. But it seems on the services side, whether we’re talking about apartment rentals, clearly a shortage, labor in the United States, another big shortage. So how do you look at this not like the 1970s inflation? How do you look at this version of inflation?
DAMODARAN: That’s psychological. That’s the part of inflation that stuff —
RITHOLTZ: So if we see inflation expectations start to come down, that should be a positive for the Fed? Because I’m not a big fan of surveys, especially expectation surveys because all you get from the survey people is, hey, here’s what happened the past three months and their psychology is reflecting that. I know the Fed pays close attention to inflation expectations. So if we see those rolling over, that would be a positive sign. We’re closer to the end of the —
DAMODARAN: I think so, and I —
RITHOLTZ: — cycle.
DAMODARAN: I think so, and I think that’s — so the Fed is keeping its eyes on wage increases in different sectors. It’s looking at pricing and subsets of services, and it’s looking for a break in that inflationary cycle. The break you need to get from 6 or 5 or wherever we are right now, to 2 percent is a pretty significant.
RITHOLTZ: Right. Hey, listen, if we had a forehand, I think the markets would rally —
DAMODARAN: Yeah. And I think that —
RITHOLTZ: — on some (inaudible).
DAMODARAN: — part of the reason is that, at some point, the Fed has to decide where the 2 is where their endgame is, or did they — there’s nothing magical about it, right?
RITHOLTZ: Right. Well, when you’re at zero, 2 looks like the way to go. When you’re at 5, 3 seems a little more reasonable.
DAMODARAN: Yeah. And I remember in the 1980s, people were saying let’s target a 5 percent inflation —
RITHOLTZ: Four.
DAMODARAN: — or a 5 percent inflation, and they were okay with that.
RITHOLTZ: Right.
DAMODARAN: So there’s nothing particularly magical about 2. And in fact, if I step back, it’s not high inflation per se, that makes it difficult to run businesses. It’s unstable inflation. In fact, I give people a choice between two economies. The first is 2 percent inflation, the second is 5 percent inflation, and ask them which economy would you rather be in as an investor, as a business? They all picked the 2 percent.
RITHOLTZ: Right.
DAMODARAN: And I say, let me change the problem a little bit. Let’s assume the country with 5 percent inflation, it’s going to be 5 percent guaranteed every year.
RITHOLTZ: It’s there forever. Right.
DAMODARAN: And the 2 percent inflation, you go from zero to 4, back to zero to 4. And so which one you’d rather be in? The answer is I’d rather be in the 5 percent guaranteed.
RITHOLTZ: It’s predictable. It’s understandable.
DAMODARAN: Exactly. It’s stability in inflation that really you’re aspiring to do. And historically, high inflation has gone with more instability, right? So I think that the Fed do not just have an inflation level in its target. It has to think of ways in which how can we make that level more stable over time.
RITHOLTZ: A bond.
DAMODARAN: A bond which is tighter because I think it makes it easier then to make long-term investments and make judgments if you have a bond that’s tighter than if it’s as wide bond?
RITHOLTZ: So let me ask you a kind of impossible question, given everything that the Fed did following September 11th and the financial crisis, and then the pandemic, has the Fed been too active, or is that too aggressive a hand on the wheel, and that’s leading to inflation volatility?
DAMODARAN: I tell you what my parents told me when I was a young child, which is children should be seen and not heard. And I would say the same thing about Fed chairman and people on the committee, I wish we saw less of them and —
RITHOLTZ: A little mystery?
DAMODARAN: — and heard less about them. I mean, I remember when Alan Greenspan was the Fed chair, not only was he a person of few words, it was difficult to extract a sentence from him. And most people wouldn’t even be able to tell you who sat on the Federal Open Market Committee in the ‘90s because it wasn’t the center of —
RITHOLTZ: Right.
DAMODARAN: — the universe like it is today.
RITHOLTZ: Right. I have a vivid recollection of him saying to a congressman, if you think you understood what I just said, then you’ve gotten it wrong.
DAMODARAN: Right.
RITHOLTZ: Like, he’s trying to be —
DAMODARAN: Opaque.
RITHOLTZ: Whereas today, so do we have too much transparency?
DAMODARAN: Yeah, I think so. I think I’m hearing too much from Fed members telling me what they think about inflation.
RITHOLTZ: Right.
DAMODARAN: I think it’d be good for the Fed to go silent —
RITHOLTZ: A little quiet.
DAMODARAN: — for a while. I mean, it doesn’t mean that the Federal Open Market don’t make this — make yourself the center of the investing universe. It’s not healthy for anybody involved in the process.
RITHOLTZ: We’ve had that problem with politicians, with central bankers. Maybe social media is to blame for some of that.
(COMMERCIAL BREAK)
RITHOLTZ: I know I only have you for a limited time, so let me jump to my favorite questions before we wrap up, starting with tell us what you’ve been either watching or listening to, what has been keeping you entertained for the past couple of years.
DAMODARAN: I’d read and watch junk. I mean, that’s — and I —
RITHOLTZ: So you read quality and you watch junk. That’s the barbell?
DAMODARAN: I don’t even read quality. I read crime novels. I love serial killer books. Mike Connelly is what I’m reading right now.
RITHOLTZ: Well, we’re going to get to your book list in a minute. What’s the junk you’re watching?
DAMODARAN: My favorite streaming service is HBO. And the reason is simple, on Netflix, you have to start — I have more false starts in Netflix than any other streaming shows.
RITHOLTZ: Really? That’s interesting.
DAMODARAN: Because I start a show and 10 minutes in, I said, I don’t want to watch this.
RITHOLTZ: Do you ever have people say to you, no, no, you got to give it three or four episodes? I’m like, that’s like you’re telling me after I watched Godfather I and II to get to Godfather III.
DAMODARAN: The reason I’m not going to do that in Netflix is their business model is to throw a hundred shows at the wall and hope that three stick.
RITHOLTZ: Right.
DAMODARAN: HBO is at the other end of the extreme, you know, whether you watch “The Last of Us” or you watch any of the shows, whether you like the show or not, clearly thought went into the show.
RITHOLTZ: Right.
DAMODARAN: It’s not something that I slapped together.
RITHOLTZ: It’s high quality.
DAMODARAN: So now, HBO remains my streaming network of choice.
RITHOLTZ: What’s your favorite shows on it?
DAMODARAN: I like “The Last of Us.” I think it was a very —
RITHOLTZ: The which?
DAMODARAN: “The Last of Us,” the show.
RITHOLTZ: “The Last of Us.”
DAMODARAN: Yeah.
RITHOLTZ: Okay. A little dark.
DAMODARAN: A little dark and a little dystopian.
RITHOLTZ: Yeah.
DAMODARAN: Normally not my — but the fact that I watched all eight episodes tells me that they were able to keep me hooked on the show, even though I’m not a “Walking Dead” fan or a fan of the —
RITHOLTZ: Right.
DAMODARAN: — strange stuff that goes on in other universes.
RITHOLTZ: So I watched the first season of “White Lotus.” I haven’t been motivated to watch the second season. I don’t know if you’ve watched —
DAMODARAN: I was. It’s a pure entertainment.
RITHOLTZ: Right.
DAMODARAN: It’s like you said, right?
RITHOLTZ: You said jarred (ph), right.
DAMODARAN: I now watch it simply because you watch it for just the craziness of what’s going on, you know. I also love Bosch on Amazon Prime.
RITHOLTZ: My wife watches that.
DAMODARAN: Because I like Michael Connelly.
RITHOLTZ: Right.
DAMODARAN: They’re like the books he writes. I like Bosch. I watched the Chernobyl documentary in HBO.
RITHOLTZ: Oh, really? Interesting.
DAMODARAN: It’s an amazing documentary. Actually, it’s a mockumentary, which is they take the documentary and they’ve made the movie.
RITHOLTZ: Right.
DAMODARAN: Really extraordinary well done. Again, a very dark story because it’s Chernobyl story, how can you make it a happy ending.
RITHOLTZ: Right.
DAMODARAN: But it actually takes you through the series of mistakes that pile up. And as you watch it, you recognize how you make $8 billion trading mistakes —
RITHOLTZ: Right.
DAMODARAN: — is you take a small mistake, you cover it up. You make a bigger mistake and then a bigger mistake. So I have fairly diverse viewing across. I mean, I have six different streaming services.
RITHOLTZ: So have you been watching anything on Apple TV since we’ve been talking Apple?
DAMODARAN: Yeah. On Apple TV, you know, I’ve been watching “Severance” and I —
RITHOLTZ: Fantastic.
DAMODARAN: — really great show. And Apple TV again is following the HBO model.
RITHOLTZ: Exactly. That’s why I brought it up.
DAMODARAN: I love “Ted Lasso.”
RITHOLTZ: Who doesn’t? Right.
DAMODARAN: It’s a fun movie. It’s a movie that leaves you feeling good after watching that.
RITHOLTZ: It’s a series. So have you started “Shrinking?”
DAMODARAN: I haven’t. That’s next on my list.
RITHOLTZ: Delightful, and cast is great and it’s full of lovely surprises. That is exactly what I was thinking is don’t throw everything on the wall. Do a small number of high — even the WeWork documentary was —
DAMODARAN: It’s good, Barry. Yeah.
RITHOLTZ: — on Apple, was really interesting. So let’s talk about mentors who helped to shape your career, both in academia, publishing and finance.
DAMODARAN: I did my PhD at UCLA and I remember it was my second year, the head of the department called me in and said, we have this visiting professor from the University of Chicago who comes here every summer because he likes to play tennis. And I said, who is it? And he said, this is a guy called Gene Fama. And I was actually Gene’s TA for those summers he used to come to UCLA. And we played more tennis then, you know. So he didn’t use me as a research assistant as much as he used me as a tennis partner, you know. But he’s a fun person to talk to.
RITHOLTZ: Yeah.
DAMODARAN: You know, you would think of him as a rigid, efficient market person. But he actually had very, very broad thoughts about markets, very pragmatic, very practical. And he told me that researchers didn’t have to be this highbrow people who thought in abstract terms, who never talked in the language that normal people use. So I worked with Jean DeCrow (ph), who was a professor at UCLA, was one of the people on my committee. But Tom Copeland was one of the people as well, and Tom was then a young professor at UCLA, went on to McKinsey. He wrote a book on valuation, the McKinsey valuation book with Tim Koller. So he actually was a great teacher. I took my first corporate finance class as an MBA from Tim Copeland.
So when I think about why I went into teaching finance, it’s because of the joy that he seemed to have in talking about finances. This guy is having so much fun talking about this topic. It must be worth exploring. So I remember that when I teach corporate finance, that I can evoke interest in people that can lead them in lots of places. And it’s not what I’m saying, it’s how much joy and enjoyment I feel, the passion I bring to a topic.
One of the people that I’ve tracked in investing that I look up to is Mike Mauboussin. I wonder if you’ve had Mike Mauboussin —
RITHOLTZ: A couple times. He’s always delightful.
DAMODARAN: Again, he’s a person who is in multiple disciplines. He can talk about the disciplines.
RITHOLTZ: He’s a polymath. Sure.
DAMODARAN: And I love talking to him because I always get good ideas about business and markets because of something he might say about basketball. He said, that’s interesting because we do that in investing all the time. The hot hand phenomenon.
RITHOLTZ: Sure.
DAMODARAN: Right. It shows up in mutual funds, where people put their money in a mutual fund. He’s got a hot hand. So they are my mentors. What I’ve learned is human beings come as a package. There are good things and bad things. And I’ve learned not to put people on pedestals because then you’re asking for disappointment.
It’s one of the pet peeves I have about people who put Warren Buffett in the pedestal. There are lots of things that Buffett does that I admire, including fact that he has a core philosophy that he goes back to no matter what happens. But there are things that he says and does, I don’t agree with. That doesn’t mean that I’m rejecting the good stuff.
RITHOLTZ: Right.
DAMODARAN: It just means I’m taking it as a package. I wish people thought about that because I get asked to mentor people. Every week, I get students writing me, can you be my mentor? And I said, maybe rather than mentoring, I can give you some guidance, but accept the fact that my guidance is not going to be perfect. Take the good stuff, reject the bad stuff, and do this with a bunch of people. You’re probably better off than holding one person up as a mentor and say, I’m going to do what that person did.
In my life’s experience, I’ve learned things from Jean. I’ve learned things from Tom Copeland. I’ve learned things from Mike Mauboussin. I’ve learned things from my Uber drivers. I mean, you can get mentorship in —
RITHOLTZ: Absolutely.
DAMODARAN: — places, you know, the shop you go into every day. The guy behind the counter is always happy even though he’s got this job of handing out coffees, you know, three a second. How does he manage to stay happy? Maybe ask him, you know, what do you do that puts you in a good mood? And the things you learn from those people are essentially going to be a package that’s going to be worth a lot more than picking a single person and a mentor, and saying, I’m going to do everything that that person does.
RITHOLTZ: Very interesting. Let’s talk about books. What are some of your favorites? What are you reading right now?
DAMODARAN: In my book, somebody has to get killed and multiple people have to get killed for that book to be exciting. So I love books in serial killers from Hannibal Lecter, you know, the —
RITHOLTZ: “Silence of the Lambs.”
DAMODARAN: — “Silence of the Lambs.” I mean, I read those books before they became movies.
RITHOLTZ: Right.
DAMODARAN: Michael Connelly who writes books about Harry Bosch who’s a detective in LA. You know, I love good writing. I love good writing to the extent that you read the book not so much because of what the story is, but because how the story is told. I mean, I love John Grisham simply because he’s a great writer. I love Stephen King because he’s a great writer. I’m not a horror story fan, but I’ll read a King book because it’s extremely well written. It keeps me engaged.
RITHOLTZ: I started reading on a plane earlier this year, Stephen King “On Writing.”
DAMODARAN: Right.
RITHOLTZ: And it’s fascinating. He essentially just is telling his own life story —
DAMODARAN: Right.
RITHOLTZ: — through how he learned to write. And really good storytellers are great storytellers.
DAMODARAN: Absolutely.
RITHOLTZ: Our last two questions, what sort of advice would you give a recent college grad who is interested in a career in finance?
DAMODARAN: Remember that finance has multiple careers. You know, you don’t have to end up at Goldman Sachs to be in finance. You could go work for a small, privately owned business in Pennsylvania, and be doing finance. Because finance basically, to me, it’s a self-serving definition. Any decision that has money involved, then it is a financial decision. Defined that way, finance is all around. You can work in a nonprofit and do finance. You can work for the government and do finance. You can work for a company. You can work for a bank. You can work for a consulting firm.
And you asked me which one of those should I pick? Part of it is lifestyle choice, right? So don’t go work for Goldman Sachs saying, look, I want a good balance of life and work.
RITHOLTZ: That’s not the place to begin. Right.
DAMODARAN: It’s not going to be there. And often, you got to accept compromises. Life is about trade-offs. And if you say, look, I want a balanced lifestyle, accept the fact that you might have to settle for a lower pay and live away from a big city because that’s where your lifestyle might best be played out.
RITHOLTZ: So a small privately owned entity in Pennsylvania, Vanguard Group, is that what you’re referring to?
DAMODARAN: It could be Vanguard Group. It could be a plumbing business in Pittsburgh. If you’re from that area, you’re a Steelers fan, you know. So I think that in a sense, if you are willing to kind of think out of the box, try (ph) finance out all over. You can pick the part of the work, where do you want to live in. You can pick the type of business you want to work for, and accept the fact that you might make 50 percent less than you might have had working for Morgan Stanley or Goldman Sachs.
RITHOLTZ: And our final question, what do you know about the world of finance and investing today you wish you knew 40 or so years ago when you were first getting started in the field?
DAMODARAN: That behavioral and emotional factors play a much, much bigger role than economics and decision-making on economic decision, starting with where you buy a house, how much you pay for a house, where you go to college, what stocks you buy. You know, it’s something that I’ve had to learn the hard way. As I’ve watched markets adjust and go through booms and busts, I’ve learned that, you know, you need to be as much psychologist as economist to think about economic questions.
And it’s made me humbler because often, when you have this rational view of the world, you know, models, you start to believe that you drive the world and the decisions there, but you don’t. You’re an observer. And when behavior is different than what you predicted, rather than pick on the people who behave differently than you predicted and call them irrational, think of this as human nature and say, why am I not factoring that in into my decision-making?
RITHOLTZ: Quite fascinating. Professor Damodaran, thank you so much for being so generous with your time. We have been speaking with NYU’s Aswath Damodaran, Professor of Finance at the Stern School of Business. Be sure and check out his new book which will be out in December of this year, “The Corporate Lifecycle: Business, Investment, and Management Implications.”
If you enjoy this conversation, well, be sure and check out any of the previous 486 we’ve done over the past eight or nine years. You can find those at YouTube, iTunes, Spotify, wherever you find your favorite podcasts. Sign up for my daily reading list at ritholtz.com. You can follow me on Twitter @ritholtz. Check out all of the Bloomberg podcasts @podcast.
I would be remiss if I forgot to thank the crack team that helps me put these conversations together each week. Samantha Danziger is my audio engineer. Paris Wolf is my producer. Atika Valbrun is our project manager. Sean Russo is my researcher.
I’m Barry Ritholtz. You’ve been listening to Masters in Business on Bloomberg Radio.
END
~~~
