MOI Global - The Dark Side of Valuation
Professor Dadar, known for his expertise in valuation, shares insights on the challenges and misconceptions in the field. He criticizes the over-reliance on multiples and the superficial use of discounted cash flow (DCF) models, advocating for honest pricing methods. Dadar highlights the role of storytelling in influencing stock prices, noting that unbounded narratives can inflate prices without basis in reality. He stresses the importance of facing uncertainty directly and adapting to changing market conditions, especially in emerging markets where traditional assumptions may not hold. Dadar also discusses the impact of intangibles on valuation, urging analysts to adjust accounting practices to reflect investments in technology and R&D accurately. He critiques the ESG movement as overhyped and emphasizes the need for investors to take responsibility for their decisions, rather than blaming external factors.
Key Points:
- Focus on honest pricing using multiples rather than fake DCF models.
- Storytelling can inflate stock prices; ensure narratives are grounded in reality.
- Face uncertainty directly; adapt to changing market conditions.
- Adjust accounting for intangibles like R&D to reflect true company value.
- ESG is overhyped; investors should take responsibility for their decisions.
Details:
1. 💡 Introduction to Professor Dadar
1.1. Professor Dadar's Background and Contributions
1.2. Discussion on 'The Dark Side of Valuation'
2. 📚 The Evolution of Valuation Studies
- Professor Damar prefers to see himself as a 'dabbler in valuation,' highlighting the complexity and surface-level understanding in the field, despite being dubbed the 'Dean of Valuation' by CNBC.
- Valuation studies began with security analysis, a field pioneered by Ben Graham, who was the first to systematically teach stock valuation at Columbia University.
- Ben Graham authored 'Security Analysis' in 1934, a foundational text for systematic stock valuation, which influenced the naming and focus of the class in valuation studies.
- Graham's work laid the groundwork for modern valuation techniques, influencing numerous financial analysts and investors, and highlighting the importance of thorough security analysis in investment decisions.
- Professor Damar's approach emphasizes the evolving nature of valuation, suggesting that while foundational texts remain important, the field constantly adapts to new financial landscapes and technologies.
3. 🔍 Honest Pricing vs. Dishonest Valuation Practices
- The evolution of a 35-year course on security analysis led to a fragmented approach, focusing on institutional information rather than valuation techniques.
- In educational settings, the lack of systematic organization resulted in a curriculum that did not prioritize teaching company valuation.
- In the industry, 95% of valuations rely on multiples instead of discounted cash flow (DCF) methods, indicating a preference for simpler, albeit less accurate, valuation techniques.
- Industry valuations often involve creating superficial DCF models that are based on multiples, undermining the depth of analysis and portraying a false sense of sophistication.
4. 📈 The Role of Storytelling in Valuation
4.1. Key Insights on Storytelling and Valuation
4.2. Theoretical Aspects of Storytelling in Valuation
4.3. Diverse Examples of Storytelling Impact
5. 🤔 Unbounded Stories and Their Market Impact
- Valuation involves 'bounded stories' that are tested for realism, contrasting with 'pricing stories' that are 'unbounded' and unchecked, often leading to inflated stock prices.
- Tesla serves as a notable example where the CEO's storytelling can significantly sway market prices, emphasizing the influence of narrative over grounded analysis.
- Investors must differentiate between rational, grounded storytelling and speculative narratives that drive prices to unsustainable levels, as seen with companies like Neo, where broad claims about the future of electric cars led to excessive valuations.
- Additional cases, such as the rise of tech startups, illustrate how unbounded narratives can create market bubbles, highlighting the importance of critical analysis and skepticism in investment decisions.
6. 🔄 The Sustainability of Business Narratives
- Managers are encouraged to construct bounded, deliverable narratives instead of pursuing grand, unbounded stories that are hard to fulfill.
- In Silicon Valley, young companies often tell big stories to boost valuations, risking sustainability as they chase unfeasible promises.
- This trend is fueled by the lure of quick financial gains, overshadowing the importance of long-term business health.
- Delivering on overly ambitious narratives can lead to business failure, as illustrated by numerous startups that have collapsed under unsustainable growth pressures.
- Case studies indicate that a balanced narrative approach, focusing on achievable milestones, enhances long-term viability and investor confidence.
7. 🛡️ Taking Responsibility in Investment Decisions
- Venture Capitalists (VCs) are judged by the return on investment, not the quality of businesses they build, emphasizing the importance of timing in their success.
- Public market investors must take responsibility for their own investment decisions instead of relying on VCs to protect their interests.
- Individuals should avoid blaming VCs or bankers for personal investment losses, such as a 50% drop in a company's value, since these decisions are ultimately their own.
8. 🎭 Embracing Uncertainty and Complexity in Valuation
- Complexity and uncertainty are often hidden or avoided in valuation, creating barriers to effective analysis.
- Uncertainty should be viewed as a feature of valuation rather than a problem to be eliminated.
- In 2020, uncertainty significantly disrupted plans, highlighting the need to address it directly rather than ignore it.
- Advises accepting uncertainty as a natural aspect of decision-making and moving forward with the best available data.
- Emphasizes the importance of aiming to be 'less wrong' than others, rather than achieving absolute certainty.
9. 🌍 Challenges in Valuing Emerging Markets
- Investing success is about being less wrong than others rather than being right.
- Emerging Markets pose significant challenges in valuation due to their instability.
- A practical example involves a business owner from Syria seeking a hurdle rate, highlighting real-world valuation issues.
- Investors in stable economies like the US and Europe have been accustomed to mean-reverting conditions, unlike volatile emerging markets.
- Assumptions based on historical stability can lead to poor investment decisions in changing macro environments.
10. 📉 The Myth of Safe Investments in Disrupted Markets
- Mean reversion is not a reliable strategy in today's economy as markets no longer revert to previous states.
- Commercial real estate, once considered stable, faces significant disruption requiring adaptability.
- Technological advancements have upended traditionally 'safe' investments like regulated utilities and phone companies, necessitating a tech-savvy investment approach.
- Disruption's 'dark side' impacts traditional industries and workers, exemplified by ride-sharing companies affecting taxi drivers.
- Few businesses remain 'safe' from market changes due to the pervasive nature of disruption.
11. 💸 Addressing Macro Risks and Currency Consistency
11.1. Macro Risks and Currency Insights
11.2. Currency Consistency
12. 💱 Inflation and Currency Effects on Valuation
- Inflation is primarily a currency phenomenon, affecting valuation based on currency choice.
- Inflation rates in countries using the same currency can vary based on the consumption basket of goods, e.g., Greece vs. Germany.
- Differences in regional inflation, such as Texas vs. New Hampshire, illustrate how local consumption affects perceived inflation.
- Inflation impacts cash flows and growth rates of countries, particularly when specific goods are disproportionately affected.
- The discount rate used in valuation maintains the expected inflation rate of the currency, irrespective of local variations.
- Currency choice in valuation (e.g., Rubles vs. Dollars for Russian companies) influences perceived inflation and valuation outcomes.
- Inflation's impact can vary across sectors, with some industries more sensitive to inflationary pressures than others.
- Case studies, such as the valuation of tech companies vs. manufacturing firms, highlight how inflation affects different business types.
13. 🔄 Using Simulations for Risk Adjustment
13.1. Currency Consistency in Valuation
13.2. Monte Carlo Simulations for Valuation
14. 🤔 Dissecting Risk and Expected Value in Investments
- The expected value of an investment, such as a stock priced at $35, may vary between $28 and $42 due to uncertainty, highlighting the importance of explicit risk assessment in investment decisions.
- Simulations provide expected cash flows but do not inherently risk-adjust these cash flows, necessitating the addition of a risk premium.
- Risk aversion in human behavior is exemplified by the preference for a guaranteed payoff, such as accepting $400,000 instead of a 50% chance of either $0 or $1,000,000 with an expected value of $500,000.
- Risk-adjusting cash flows involves reducing the value below the expected cash flows, emphasizing the need for risk adjustments in simulations and scenario analyses.
- Probability adjustments represent expected cash flows, not risk adjustments, and should not be confused with risk-adjusted cash flows. Analysts must avoid misinterpretation of these statistics.
15. 🎲 Understanding Human Behavior in Risk Aversion
- Risk aversion leads individuals to prefer certain outcomes over probabilistic ones, even if the expected value is higher in the probabilistic option; for example, choosing a guaranteed $450,000 over a 50% chance to win $1,000,000.
- Financial models incorporate risk adjustment to account for human behavior, differentiating between expected cash flows and actual risk-adjusted values, emphasizing the practical implications of risk aversion.
- In practical scenarios like game shows, participants often accept offers below the expected value due to risk aversion, illustrating its impact on real-world decision-making.
- Psychological aspects of risk aversion highlight why individuals might reject higher-value probabilistic outcomes due to fear of loss, despite potential gains.
- A deeper exploration into the psychological basis for risk aversion could enhance understanding, focusing on how fear and uncertainty influence decision-making processes.
16. 🔍 Evaluating Risk Through Expected Returns
16.1. Risk Neutrality vs. Risk Aversion
16.2. Gambling and Risk Preferences
16.3. Calculating Expected Value and Risk
17. 🔄 Adapting Strategies in a Changing Investment World
- Expected value calculations can misrepresent the level of risk involved, as they do not account for risk aversion. For instance, with a 50% chance of earning nothing and a 50% chance of earning a million, the expected value is $500,000, yet individuals may accept a lower guaranteed amount due to risk aversion.
- Investment decisions require reaching a consensus estimate that considers varying individual perceptions and risk aversions. This consensus is vital for determining the expected return used as the discount rate in risk and return models.
- Warren Buffett's strategy focuses on investing in companies with predictable earnings. This approach has been successful for two decades but faces challenges due to increasing business instability and disruptions.
- Different levels of risk aversion significantly influence investment choices. For example, more risk-averse investors might opt for bonds over stocks, even if the expected return is lower, to ensure stability.
- A practical example includes adjusting investment portfolios to balance risk and expected return, by diversifying assets to mitigate potential losses in volatile markets.
18. 🧩 Rethinking Circle of Competence in Modern Markets
18.1. The Fallacy of Predictability
18.2. Challenges and Necessity of Adaptation
18.3. Reevaluating Circle of Competence
18.4. Beyond the Circle of Competence
19. 👥 Accepting Responsibility and Self-Awareness in Investing
19.1. Wealth Preservation and Growth
19.2. Investment Enjoyment and Risk Management
19.3. Self-Awareness and Responsibility
20. 📊 Intangible Assets and Their Impact on Financial Statements
- The current accounting standards misclassify intangible assets like R&D and technology as operating expenses instead of capital investments, leading to misleading financial statements.
- This misclassification particularly affects technology firms whose value relies heavily on intangible assets, making earnings reports from companies like Microsoft incomparable to traditional manufacturers like GM.
- Outdated accounting practices, which are approximately 50 years behind modern business needs, fail to reflect the real value of companies with significant intangible assets.
- To address these challenges, financial statements should be adjusted to treat intangible assets as capital expenses, providing a more accurate reflection of a company's value.
- Industries dominated by intangible assets, such as technology, experience significant discrepancies in financial reporting compared to those with tangible assets, highlighting the need for revised accounting practices.
21. 🔍 Effectively Analyzing Intangibles in Business Valuation
- Valuing companies like Microsoft, Apple, or Google requires additional analysis but it's manageable and gives more control than relying solely on accountants.
- Understanding which expenses are for current operations and which are for future growth, such as R&D, is crucial.
- Distinguishing between operating expenses and investments in future growth, like advertising to build brand value, is challenging.
- Customer acquisition costs should be scrutinized by asking about churn rates to determine if they should be considered operational expenses.
- Investors and analysts need to ask companies follow-up questions to accurately assess intangibles, such as the value of subscribers in different regions.
- A strategic approach involves breaking down intangibles into categories, such as brand value, customer loyalty, and technological innovation, and assessing each separately.
- Utilize specific metrics like customer lifetime value (CLV) and regional subscriber growth to measure intangible asset contributions.
- Case studies of successful companies can provide insights into effective intangible analysis.
22. 🎬 Balancing Content Creation and Business Investments
- Netflix continuously invests in new content similar to how manufacturing companies invest in new factories, emphasizing the need for ongoing and strategic investment in both new and existing shows.
- The traditional view of capital expenditure is being rethought, equating investments in new shows to launching new products, highlighting the critical nature of intangible investments.
- Valuing companies that invest heavily in technology and content creation requires practical experience, underscoring the importance of real-world applications over theoretical learning.
- The challenge in adapting to new valuation approaches can be mitigated through practice, suggesting the importance of starting with practical, real-world applications.
23. 🤝 Assessing Quality Management and Business Outcomes
- Quality management should be reflected in financial metrics like earnings and cash flows; failure to do so questions the authenticity of the quality claim.
- Amazon is often cited as an example of high-quality management due to its consistent delivery of better-than-expected results, demonstrating the financial impact of effective management.
- The term 'high quality management' is frequently used as a buzzword. Without numerical evidence, it may indicate that more critical business aspects require attention.
- Companies should prioritize quantifiable financial outcomes over subjective assessments of management quality to ensure genuine business success.
24. 📈 Navigating Growth and Disruption in Business Strategy
- Two-thirds of management teams globally destroy value as they grow, with 30,000 out of 45,000 companies having management that detracts value instead of adding it.
- The perception that all management teams are high-quality is often misleading, as the median management team is below average.
- Growth does not always equate to value creation, especially in industries like airlines where expansion can be detrimental to value.
- There is a cultural bias towards growth, with societal narratives often glorifying expansion rather than strategic contraction or stabilization.
- Tangible metrics and evidence are necessary to validate claims of a high-quality management team, rather than relying solely on self-proclaimed excellence.
25. 🌱 ESG and Its Role in Corporate Responsibility
- ESG is criticized as being overhyped and lacking substance, primarily benefiting consultants and advisors rather than investors or employees.
- The current ESG movement pressures companies to prioritize virtue signaling over real impact, acting more like 'churches' than businesses.
- The speaker suggests legislative action, not corporate self-regulation, as the proper means to achieve societal good.
- Criticism is directed at consumers and politicians for expecting companies to self-regulate without taking responsibility themselves.
- There is a prediction that ESG will enrich consultants but result in companies that only superficially appear virtuous.
26. ⚖️ Simplifying Complexity in Valuation Approaches
- Companies are often expected to do more for society, but the expectation that they can simultaneously achieve social good and remain highly valuable is unrealistic. This reflects a societal desire to 'have our cake and eat it too,' which rarely works in practice.
- The advice for developing the right mindset in valuation is to be willing to be wrong. Embracing the possibility of being wrong fosters creativity and adaptation, which are crucial for evolving valuation methods over time.
- A key distinction in valuation is between precision and accuracy. Precision is about getting the same result repeatedly with a model, while accuracy focuses on reaching the correct answer, even if the model is inconsistent. The emphasis should be on accuracy rather than precision in valuation approaches.
- For instance, when evaluating a tech startup, focusing on precise metrics like short-term revenue may lead to overlooking the potential for long-term disruptive impact, which is a more accurate indicator of value.
27. 📚 Final Thoughts and Recommendations
- The speaker highly recommends the book 'Valuation' for its comprehensive insights into financial analysis and valuation techniques.
- The author is praised for sharing valuable knowledge through this book, highlighting its practical applications for both new and experienced professionals.
- Specific examples from the book demonstrate how valuation principles can be applied to real-world business scenarios, enhancing understanding and strategic decision-making.
- The book is noted for reducing complexity in financial valuation, making it accessible and actionable for a wide audience.
- The speaker underscores the importance of integrating these valuation techniques into everyday business practices to improve financial outcomes and strategic planning.