Speaker 1: Bloomberg Audio Studios, podcasts, radio news because I gotta have fame.
Speaker 1: Oscar Wilde once described a cynic as a man who
Speaker 1: knows the price of everything, but the value of nothing.
Speaker 1: Nowhere is understanding value more important than in the stock market. Sure,
Speaker 1: prices get quoted every second, every tick, but value that's
Speaker 1: a much more challenging problem. Whether you're buying broad indices
Speaker 1: or purchasing specific stocks, it pays to not be a
Speaker 1: cynic and understand both price and value of your investments.
Speaker 1: I'm Barry Ritolts, and on today's edition of At the Money,
Speaker 1: we're going to explain how to become more savvy about
Speaker 1: understanding equity values. The value you pay for your investment
Speaker 1: has an outsized impact on your long term returns. To
Speaker 1: help us unpack all of this and what it means
Speaker 1: for your portfolio, let's bring in Professor Aswath Damaduran of
Speaker 1: NYU's School of Business. He is often referred to as
Speaker 1: the Dean of valuation for his extensive work in the area.
Speaker 1: He's written numerous books on the subject, including Damadoran on Valuation,
Speaker 1: Narrative and Numbers, and the textbook Investment Valuation Tools and Techniques.
Speaker 1: For determining the value of any asset. So, Professor, let's
Speaker 1: just start with the basic question, why are valuations so
Speaker 1: important when it comes to equities.
Speaker 2: I'm going to give you a cynical answer. They're not
Speaker 2: important if you're a trader. Traders live on pricing. In
Speaker 2: the essence of pricing is you buy at a low price,
Speaker 2: you set at a high price, and it doesn't really
Speaker 2: matter why the price changes if you get the direction drive,
Speaker 2: value matters if you're an investor. To me, the definition
Speaker 2: of an investor is you buy something for less than
Speaker 2: what it's worth. And the essence of values, you're trying
Speaker 2: to estimate what something is worth. But most as I said,
Speaker 2: it depends on the philosophy you bring in. Are you
Speaker 2: an investor or your trader, because that's going to dry
Speaker 2: whether value matters to you.
Speaker 1: So let's talk about identifying that intrinsic value of what
Speaker 1: something is worth with any specific company. How can you
Speaker 1: determine that valuation.
Speaker 2: It's as old as time that Venetian glass maker is
Speaker 2: sold as business in the Middle Ages. Probably sold it
Speaker 2: to somebody bought it because of the cash flows he generated,
Speaker 2: the risk in those cash flows, and how much those
Speaker 2: cash flows are going to grow. It's cash flows, growth
Speaker 2: and risk. That's the essence of value. That's always been true.
Speaker 2: We act like we invented valuation in the last century
Speaker 2: in finance because we came up with all these neat
Speaker 2: little models and metrics to measure risk and bring it
Speaker 2: into what you need to make. But always been driven
Speaker 2: by cash flows, growth and risk. And how you get
Speaker 2: to that value can come from different pathways. I use
Speaker 2: intrinsic valuation, you know, in that sense as capturing anybody
Speaker 2: who thinks about those fundamentals.
Speaker 1: So let's dive into that intrinsic valuation based on cash flow,
Speaker 1: growth and risk. What different ways are there to measure
Speaker 1: the fundamental value of a company? And how do these
Speaker 1: different valuations reveal intrinsic value?
Speaker 2: I mean, ultimately, cash flows, growth and risk are not
Speaker 2: going to be different for different people. The way we
Speaker 2: think about risk, though, can differ depending on who you
Speaker 2: are as an investor and what do you think matters.
Speaker 3: I mean, I'll give you an example.
Speaker 2: In traditional finance, we think about risk by looking at
Speaker 2: how prices move for a stock relative to the market.
Speaker 3: But there are intrinsic value.
Speaker 2: People argue that true measure of risk is what happens
Speaker 2: to your earnings. Your revenues are operating metrics. So even
Speaker 2: within people who believe in intrinsic value, we can have
Speaker 2: disagreements about how to measure risk, what is the right
Speaker 2: cash flow to look at, and what's the growth rate
Speaker 2: that you think about over what periods. So while we
Speaker 2: might have twenty people in a room, all of whom
Speaker 2: buy into intrinsic value, we can come up with twenty
Speaker 2: different estimates of intrinsic value for the same company at
Speaker 2: the same point in time.
Speaker 1: So we always hear about price to sales, price to book,
Speaker 1: price to earnings. Are these all that different, They're just
Speaker 1: variations on fundamentals, or are they very different ways of
Speaker 1: looking at the same company.
Speaker 2: Philosophically, they're very different because when you compute the price
Speaker 2: earnings or the ev Tabidov price to book for a company,
Speaker 2: what you do is you compare to other companies out there,
Speaker 2: and you make a judgment and saying, in this company
Speaker 2: trades at ten times earnings, other companies like it, and
Speaker 2: I'm going to put quotes on like it trade at
Speaker 2: fifteen times earnings. Therefore as cheap, that's a pricing judgment.
Speaker 2: There's nothing value in here, there's no intrinsic value judgment.
Speaker 2: That's why all of seal side equity research, I would argue,
Speaker 2: is all about pricing.
Speaker 3: It's not about valuation.
Speaker 2: Nothing wrong with it, but we should be honest about
Speaker 2: what we're doing. So when you use ratios, it's because
Speaker 2: you want to find something cheap by comparing it to
Speaker 2: other things out there that are being traded right now,
Speaker 2: and you're looking at what other people are paying, so.
Speaker 1: You're looking at price. When people look at stocks that way,
Speaker 1: they're looking at price and relative valuation, non intrinsic value.
Speaker 1: Let's talk about some of the things you've explained in
Speaker 1: your books. Valuation requires a deeper understanding of the business,
Speaker 1: including how it makes money and its future prospects. Give
Speaker 1: us a little more detail on that.
Speaker 2: I'll give you an example, and it's a personal example.
Speaker 2: I bought in Media purely by luck in two thousand
Speaker 2: and eighty. I didn't see AI coming, none of this stuff.
Speaker 2: So sometimes your best investments happened by accident. So last
Speaker 2: year I had to revalue in Vidia for a simple reason.
Speaker 2: I mean I bought it at twenty seven dollars per Yeah,
Speaker 2: the stock was trading at eight hundred dollars per share,
Speaker 2: and I had to decide is it time to leave?
Speaker 2: So as I sat down to value VideA, I started
Speaker 2: with a presumption that was a computer chip company that
Speaker 2: had made chips and sold them, and I had to
Speaker 2: estimate cash flows based on that. It's only as I
Speaker 2: started digging a little deeper that I realized that they're
Speaker 2: not a chip maker, They're a chip designer. Every Invidia
Speaker 2: chip is made by TSMC, which basically changes the way
Speaker 2: you think about the business. If you're doing pricing, you
Speaker 2: might be able to gloss over it, it doesn't matter
Speaker 2: that they do it, but if you're doing intrinsic valuation,
Speaker 2: because I have to estimate cash flows, I have to
Speaker 2: think about what is it that they spend to create
Speaker 2: these revenues, and that requires an understanding of how they
Speaker 2: conduct their business. I mean Warren Buffett a famous saying
Speaker 2: that he doesn't buy stocks, he buys shares of businesses. That,
Speaker 2: to me, in essence, is what you're doing in intrinsic valuation.
Speaker 2: You're not buying a share of Apple or a share
Speaker 2: of Amazon. You're buying a slice of those businesses. That's
Speaker 2: what you're doing. You better understand what you're buying before
Speaker 2: you pay a price.
Speaker 1: So can we apply the same theory of valuation to
Speaker 1: broad indices as opposed to just individual stocks.
Speaker 2: Absolutely, I mean it's cash flows, growth and risk drive
Speaker 2: the value of Invidia. Cash flows, growth and risk, because
Speaker 2: what drives the value the S and P five hundred
Speaker 2: or the nasdat. In fact, that's the process I use
Speaker 2: at the start of every month to come up with
Speaker 2: an estimate or what investors are pricing in the S
Speaker 2: and P five hundred and what they can expect to
Speaker 2: earn given the cash flow. It's a very intrinsic value
Speaker 2: view of what can you expect to make as a
Speaker 2: rate of return on an index.
Speaker 1: So that raises, you know, the real important question, what
Speaker 1: do these measures of evaluations mean for future expected returns?
Speaker 2: The more you pay for something, let's cut away from
Speaker 2: all of the noise in this process, The more you
Speaker 2: pay for something upfront, the low you're expected returns are
Speaker 2: going to be. Because if you pay more upfront, and
Speaker 2: that's just common sense. So when you buy the S
Speaker 2: and P five hundred at fifty three hundred, you can
Speaker 2: expect to earn a lower return than if you bought.
Speaker 3: It at fifty one hundred.
Speaker 2: So if you bought it last week, your expected denerve
Speaker 2: was lower than if you bought it today.
Speaker 3: And that's at the basis of intrinsic value.
Speaker 2: It's about paying the right price for something upfront.
Speaker 3: Is the most critical decision you make.
Speaker 1: So you consistently in all your books emphasize that value
Speaker 1: is not price. So how should investors think about the
Speaker 1: difference between the quoted fluctuated price we see every day,
Speaker 1: the quoted fluctuating price that we see every moment on
Speaker 1: the market, and that deep intrinsic value.
Speaker 2: Recognize there are two different processes. Nothing makes one better
Speaker 2: than the other. Different processes. Values driven by changes in
Speaker 2: your earnings, cash flows, growth risk, and that's captured by
Speaker 2: changing value over time. So I'm not saying intrinsic value
Speaker 2: somehow stable stagnant number. The intrinsic value in radio doubled
Speaker 2: because of its entry into AI. Intrinsic value can change.
Speaker 2: Price is driven by demand and supply, driven by mood
Speaker 2: and momentum, and I think one of the best indicators
Speaker 2: you can take a mood and momentum is when the
Speaker 2: momentum is good All news is good news. In fact,
Speaker 2: there's a whole segment of finance called behavioral finance, and
Speaker 2: behavioral finance tries to explain why price can not only
Speaker 2: deviate from value but stay different for long periods. There
Speaker 2: this inherent belief that value investors have that price will
Speaker 2: move towards value and it will happen quickly. That's not true.
Speaker 2: Price can deviate from value. It can stay separated from
Speaker 2: value for long periods, which means if you're an intrinsic
Speaker 2: value investor, you're going to get incredibly frustrated because you
Speaker 2: think you got.
Speaker 3: It right, but you keep losing money.
Speaker 1: So you're referring to mean reversion. The expectation is that
Speaker 1: pricey things eventually come back down to fair value, and
Speaker 1: inexpensive things will eventually be recognized and return to fair value.
Speaker 1: How long does this process take? Is it guaranteed to happen?
Speaker 1: Does that mean reversion always occur?
Speaker 2: It's not just mean reversion, it's assumption that values what
Speaker 2: matters in the long term.
Speaker 3: I mean that's almost ill. I mean when I.
Speaker 2: Start my valuation class, I started the question do you
Speaker 2: have faith? My students look at me, say it's evaluation class.
Speaker 2: What are you talking about? I said, the essence of
Speaker 2: investing is faith. Faith that your estimated value is the
Speaker 2: right value, and faith that the price will move to value.
Speaker 3: And the essence of faith.
Speaker 2: If you asked me to prove it, and if you
Speaker 2: told me, tell me what will cause it to.
Speaker 3: Happen, my answer is, I don't know. It's a mystery.
Speaker 3: I mean, it's like.
Speaker 2: Going to church and going up to your pastor or
Speaker 2: your rabbi and saying, can you give me some proof
Speaker 2: that God exists?
Speaker 3: I keep coming back every you know, every week.
Speaker 2: Because I and if that rabbi, a priest or you
Speaker 2: know is telling you the truth, they should say look enough.
Speaker 3: I can't give you that proof. It's faith.
Speaker 2: And I think that's what makes investing so difficult is
Speaker 2: it's driven by faith rather than by proof. So if
Speaker 2: you ask me, you know, if I bought something undervalued,
Speaker 2: am I guaranteed to make money in the long term?
Speaker 3: Absolutely not. And you have to be okay with it.
Speaker 2: If you're not okay with it buying a text file,
Speaker 2: don't invest or be a trader. The essence of investing
Speaker 2: is you can do everything right and I have nothing
Speaker 2: to show for it, and you have to be okay
Speaker 2: with that.
Speaker 1: Wow, So, professor, bottom line it for us when we
Speaker 1: think about valuation, when investors look at equities, what should
Speaker 1: be foremost in their minds before deploying capital?
Speaker 3: Pwice.
Speaker 2: Be honest with yourself, Now, what is the game you're playing?
Speaker 2: If you're playing the trading game, don't lie to yourself
Speaker 2: about caring about fundamentals and earning and cash flows.
Speaker 3: Just play the trading game.
Speaker 2: Look at charts, look at technical indicators, look at mood
Speaker 2: and momentum, because that's what you're playing. If you want
Speaker 2: to be an investor, you need to do your homework.
Speaker 2: You can't hide behind the fact of I've never done
Speaker 2: an accounting or evaluation classet or understand these financial statements.
Speaker 3: The essence of investing.
Speaker 2: Is you've got to be able to look through those
Speaker 2: financial statements and be able to gauge the value of
Speaker 2: a company. You might not want to use the full
Speaker 2: technology of intrinsic valuation, but you need to start thinking
Speaker 2: about businesses and value in a much more in a
Speaker 2: much deeper way than you're doing right now. If that's
Speaker 2: not your thing, that's fine. There are lots of people
Speaker 2: who get richest traders, and there's nothing wrong with trading.
Speaker 3: Just play that game well.
Speaker 1: So to wrap up, investors who have a long term
Speaker 1: time horizon should be very aware of the variations in valuations.
Speaker 1: The more you pay for a given stock or a
Speaker 1: given market index, the lower your future expected returns are.
Speaker 1: Understand that there are no guarantees in the market, and
Speaker 1: merely buying cheap stocks is no guarantee that you're going
Speaker 1: to outperform or even market perform in the future. I'm
Speaker 1: Barry Retults and this is Bloomberg's at the money.
Speaker 3: I gotta have