The Value of Stories in Business | Aswath Damodaran | Talks at Google

team in history has won 147 games in a row. It's possible, but not plausible and definitely not probable. Three different levels of testing. Once I have established that my story is possible, plausible and probable, comes what I call the craft part of the assessment. And this is what I mean by the artisanal part. I have to be able to take every part of my story and turn it into a number in my assessment. And you say, what if my story can't become a number? I see it as a challenge when someone says: I have a variable that you can't or I have a story that you can't... you tell me a story, I will find the number and a valuation to reflect it.

And once I convert my story into numbers, the assessment takes care of itself. When you look at the valuation, it's my story that drives the valuation. So if you point to a number in my rating, you should be able to back it up with history. And then comes the hardest part. So you've told this great story, right? Do you like your story? Yes of course. It's your story. You have turned history into an assessment. Do you like your rating? Absolutely. And when you present that assessment to other people, what do you want them to tell you?

This is incredible. This is exactly how I will

value

the company. So here's my advice to you: don't talk to people who think the same as you. Don't hang out with people who think the same as you because they'll say, "This is amazing." That's exactly how I would

value

the company as well. So this is what I call keeping the feedback loop open. Look for people who think less like you. When you present your review to them, you know what they're going to say, right? This is horrible, it's a stupid way to value a company. Listen because they may be telling you things that can improve their story.

So what I'm going to do is take two companies through this process so they can see how this game develops. And I know you know the two companies I'm going to use. And the reason I'm going to choose well-known companies is because this is what I would like you to do. As I tell my story, I would like you to think about how wrong my story is. So I want you to think about what you don't agree with in my story, but don't interrupt me. This is my story, my turn. But when I'm done, I'm going to give you an architecture where you can take your story about these companies and do it with your valuations.

To me, that's the essence of investing: taking ownership of your own

stories

. Here are the two companies I am going to use. The first is Uber in June 2014. So why does timing matter? Because my story about Uber changes over time. Why does it change? Because the world revolves around me. In fact, I reviewed Uber on my blog in June 2014, September 2015, September 2016, and I plan to do so again in a month. And my

stories

change and I'm not ashamed to admit the fact that my stories change all the time. The second company I am going to value is Ferrari in October 2015, just before its initial public offering.

In fact, Ferrari has been around for a long time, since the 1940s. But in the 1960s, Enzo Ferrari got into trouble and had to sell 90% of Ferrari to Fiat Chrysler and for about 50 years, Ferrari remained as part of Fiat Chrysler, until 2015, when it was spun off as an independent company. . So I'm sure everyone in this room is at least familiar with what Uber does and what Ferrari does. These are stories that should sound familiar to you. So let's start the game. The first step in the process before telling a story is to understand the company, understand the

business

.

One of my problems with the way research has evolved is that it has focused too much on financial statements. When I ask you to investigate, what do you do? You compile financial statements. And the other thing that has become a problem is Google searching because when I ask you to do research, what do you do? Type the name of the company and hundreds of articles appear. That's not a bad place to start, but it should never be the place to end. You know what you learn more about a company? Talk to people. Talk to people who use the product, talk to people who work at the company.

It is necessary to understand what the company does, what motivates it, to be able to value it. So I'm going to tell you when I first heard about Uber and when I say this, you're going to laugh. Are you saying you didn't find out until then? I heard about Uber in June 2014. Are you saying, what were you doing living under a rock? In fact, he lived underground. Since I live in New York City, I take the subway, I never take the surface roads. Because who wants to deal with traffic? Then I see this new story in the “Wall Street Journal” that says a venture capitalist has valued Uber at $17 billion.

Notice the word I used. I used the word price, not the word valued. So let me put this on the table. No venture capitalist in history has valued anything, they have put a price on things. It's a very different game because as a venture capitalist, you win, you buy at a low price and you give it to someone else at a high price. They had valued it at 17 billion dollars. And I said I hadn't heard of Uber, but that was kind of a lie. I had seen the word Uber on my credit card statements in the three months leading up to June 2014 because it turned out that my son, who was going to college in North Carolina, was using Uber and my credit card to back it up.

I don't know how that happened. But to be honest, I thought I was taking German classes. the no umlaut in the U should have given it away. So I called him, but he was still sleeping. It's like 11:30 in the morning, college student time, which means you go to bed at like 5:00 and wake up at noon. So I called my niece, who worked in Chicago, and she was on her way to work and was not in a good mood. So I said, what is this Uber? She said it's a ride-sharing service. I said, what the hell is a ride-sharing service?

She said: I don't have time to tell you. Why don't you download the app and find out for yourself? So I hang up the phone, download the app, and hit it. Magical things start happening on my phone. I see a GPS open and I see a car trying to get to me. It's New York City: you're just trying to get somewhere, but you don't really get there because they're one-way streets. And I could see a guy named George sitting in the front seat. This has never happened to me with a yellow taxi. The car stops, and I run to the car and say, Hi, George.

He says where do you want to go? I said, I don't want to go anywhere. Can you take me about 30 or 40 minutes? I have some questions to ask you. He thought I was a serial killer, but then he looked at me and said, I can take care of this guy. Get in the back seat. So I sit in the back seat and start asking him questions. I said, is that an Uber car you're driving? He said no. This is my car. I said, are you an Uber employee? He said: I'm an independent contractor. I said, why are you doing this?

He says I have a regular job. I don't make enough money and this allows me to earn a second income with a car I already own. I said, why do you need Uber? He said without Uber I can't pick up people on the street. It is illegal in New York City to stop at someone on the sidewalk and say: Do you want a ride? Uber is my matchmaker. So at this stage I could understand why this guy used Uber, because it allowed him to take a car he already had; In fact, I asked him, do you pay additional insurance?

He said: I don't mention it to the insurance company. What they don't know, they don't know. Basically, he was taking the car, he was using the insurance he already had and earning a second income and Uber was the matchmaker that allowed him to do that. Then he lets me out in front of my office. I offer to pay you. I should have accepted the money. He said, you don't have to pay me. I said, is it free? He said no, it's not free. When you downloaded the app, were you asked for a credit card number? I said yes and bells ring in my head.

They are going to charge you. And I said, how do they pay you? He said they will send me 80% of whatever the fee is. I remember asking, why 80%? He said, I don't know. That's what everyone does. Now he could understand why Uber did what he did. Basically, because they were matchmakers, they charged 20% of what you paid. I said, this is a big

business

. Which he left me with a missing piece: why do customers like Uber? So this time I called my son at a civilized time, like 3:30 in the afternoon, when he was already awake. And I decided to put him on the defensive right away.

I said, I've noticed you've been using my credit card to support your rideshare. I made it seem like I knew what Uber was doing all the time. You have your own car, why do you need Uber? He said: Dad, some nights I like Uber. Some questions as a parent that you don't go too deep into. In a way I understood it. But this is a kid who I can't even imagine hailing a traditional taxi. It's not even in his frame of reference to go outside and... you know. I said, what do you like about Uber? And he said, I can call the car from my phone.

And I said, these cars must cost you a lot more than a taxi, right? He said no, they are cheaper than a taxi. I said, you have to wait a lot longer, right? He said, no, no, they come faster than a taxi. I said, these cars must be dirty, right? They are cleaner than a taxi. I said, let me get this straight: They are cheaper than a taxi, they are faster than that taxi, they are cleaner than a taxi. That's when I knew the taxi service was doomed to fail. We can dance all you want. The last question I had to figure out was: why couldn't I do this in my basement?

It could be a matchmaker like Uber. And I came up with three answers in June 2014. The first was $3 billion. That's what they raised from the VC. He didn't have 3 billion dollars. That puts me at a disadvantage. The second is that this is a game with networking benefits, you know what I mean? As you sign up more drivers, it becomes... a new driver wants to join, they will go where the rest of the drivers are because the bigger the space, the more likely they are to get customers. And the third is that it is a company that uses data in ways that it has not been used before.

Like what? The increase in prices, for example. So when I talk about understanding your company, I essentially mean learning more about what your company does (why people like your products, why they work for it) and getting an idea of ​​what the business model is. So, to complete the story, after doing this research, if you can call it that, on Uber, I made a drawing, and I try to do this with almost every company that I value, a picture of what the company does, what what produces, who buys from the company, why they do it. In the case of Uber, what completes the story is that they have a business model (and I was able to verify this in June 2014) that is easily scalable.

Do you know what I mean by easily scalable? For Uber to go to a new city, all you need to do is hire a person, put them in a motel room, and say: sign up as many drivers as you can. There is no investment in infrastructure. They don't buy the cars, which means they're going to... it has pros and cons. It means they can grow much faster, that's a plus. What is a minus? It means that other people can use the same thing, so it is a business that will grow quickly, but it will be difficult to defend it and make money from it.

At least in June 2014 I had an idea of ​​what Uber did. Let's move on to Ferrari. Technically speaking, it's a car company, right? That's the bad new. Why is it bad news? Because this is not a big business. It is one of the 10 worst businesses in the world. It sounds like a categorical statement, but every year I rank the 10 worst businesses. Online advertising hasn't gotten there, so don't worry. Your businesses are safe. The car business is a terrible business. Let me begin by laying out the basis for that statement. In the 10 years before 2015, which was when Ferrari went public, annual revenue growth for global automotive companies was only about 5.6%.

That's all. This is quite anemic growth. And where does half of that growth come from? I tell my MBA students that when someone asks you a question you don't know the answer to, say China. It's surprising how often that is a good answer. Whatever the question, China works. Why are interest rates low? Porcelain. Why are interest rates high? Porcelain. Why is inflation rising? Porcelain. It's like six degrees of separation from Kevin Bacon. On every question, China is six degrees away from Hey, that's the right answer. That is, a growth of 5.6%; half comes from China. You're saying, so what?

If China slows down, 5.6% will become 4%. Operating margins are abysmal. The average operating margin (so it's not a net profit margin, it's higher on the income statement) is 4.4%. And 1/3 of all car companies lose money. So revenue growth is low and margins abysmal, let's close the coffin withnails. Typically, when revenue growth is low, one of the few advantages you get is that you don't need to reinvest much. But in the case of automobile companies, that is not true because they have had to reinvest not in assembly lines, but in R&D. Do you know why they have to invest in R&D?

The modern car is more of a computer than a car, so they had to invest in R&D to catch up. This is your definition of a bad business: low revenue growth, abysmal margins, lots of reinvestment. The way this plays out is that in nine of the last 10 years leading up to 2015, auto companies earned a return on equity less than the cost of capital. That's the bad news for Ferrari: they are in a bad business. The good news for Ferrari is that it's not just another car company, right? In fact, I'm not even sure if it's a car.

It is a very impractical car. There's a guy in my town who has a Ferrari, I've never seen him drive it. It is stored in an extra armored garage with two security guards in front. You could enter his house several times, but his car is protected. Rumor has it that once a year he takes the car out of the garage and drives it around town, puts it back in the garage and locks it for the following year. And who can blame the boy? What are you going to do in your Ferrari, go shopping? Can you imagine parking your car and walking to the supermarket?

AUDIENCE: In many of them, insurance covers only weekends. ASWATHDAMODARAN: There you go. And even on the weekends, you'll probably have to have two guards running alongside your car to make sure no one scratches it while you're driving it. You can't go to the supermarket. How about carpooling in a Ferrari? You have to pick up four children, one seat. What are you going to do, stack them? So why would people spend all this money buying a car that can't be driven anywhere? Because you are part of a very exclusive club. How exclusive? Let me give you a photo.

In all of 2014, the year before the IPO, Ferrari sold 7,255 cars worldwide. Throughout the year, 7,255. Think about it. That's how many cars Volkswagen probably rejects each day on its assembly line. 7,255 throughout the year, that is bad news. The good news is that its operating margin is 18.2%. Remind me again what it was or the rest of the car business. 4.4%. So why is your margin so high? One answer is because they have priced the car too high. The other is that they spend almost nothing on traditional advertising. Have you ever seen a Ferrari advertisement on television? Come in, 10% discount.

He's not the kind of person they want coming. In fact, I'm not even sure how you buy a Ferrari. When you walk in, the shopkeeper probably asks you: Do you have any references? To what? Billionaires, you know. Don't know any billionaires? Get out of here. It's an exclusive club, they can't let the riffraff leave the streets and buy a Ferrari. Therefore, it does not sell many cars and has high margins. And here is the final advantage. Normally, when you sell these high-priced luxury items like Tiffany and Guccis, in good times you sell a lot; The economy affects you, because people are looking to buy your things.

That has not been true at Ferrari. They have sold about 7,200 cars in the 10 years leading up to 2014, including 2009. Do you know why I chose 2009? The year after the crisis it was expected that sales would fall. Nothing happened at Ferrari. Why not? The people who buy Ferraris are so rich that if you ask them what the economy is doing, their answer is: what is an economy? Because to them the essence of a bad year is that I'm only worth $4.5 billion instead of $7.5 billion, not exactly cutting corners or cutting costs. So the final advantage that you get is that you're actually making a pretty steady income despite having this luxury product because you've kept it so exclusive.

All of those things will unfold when I tell you my story for Ferrari. Let me talk about business stories. What exactly is a business story and how to tell it? If any of you are an entrepreneur, want to be an entrepreneur, dream of being an entrepreneur, take this for what it's worth. If you're telling a business story, keep it simple. Unlike what? Don't be all George RR Martin and tell me a "Game of Thrones" story. I still remember trying to read the first "Game of Thrones" book. Halfway there I gave up. There are like hundreds of characters.

They die. They come back to life. There are like six empires. I said, I'm too old for this. If you count "Game of Thrones," you don't have seven seasons and 70 episodes to tell the story of your business, you probably have five minutes. Keep it simple and keep it focused. What is the ultimate goal of each business? You have to show me a way to make money. Pathway doesn't have to be next year, it could be seven years from now. So don't keep talking about how many users you have. How nice. Tell me how you plan to turn these users into profits.

That might happen in the future, but without thinking about it, it won't magically happen. So I'll try to follow those rules when trying to come up with stories for Uber and Ferrari. In June 2014, this was the story I told for Uber. And every word in the story will have consequences, so hang in there. I described Uber as an urban car services company. So I'm already trying to tell you where I think Uber will be successful, right? Urban means cities and big towns, car services are the basic business. Remember how I said I wanted you to think about how you disagree with my story?

So, given Uber's current situation, let's start thinking that's wrong. Okay, but this is my story from June 2014, an urban car service company that will attract new users to the car service business. Like who? Like my son, people who normally never take a taxi have now tried taking this transportation service. With the benefits of local networks, I have already talked about what the benefits of local networks are. As you become the largest rideshare company in New York, there is a tipping point where you will basically end up dominating the market. You think, what is the place doing there?

Let's say Uber becomes the largest car service company in New York and I fly to Chicago. I don't care about the biggest car service company in New York, now I care about the biggest car service company in Chicago. So, in my story, this is what is going to happen. Uber may end up dominating New York, Lyft may end up dominating Chicago, Didi Chuxing may end up dominating Beijing, and Ola may end up dominating Mumbai. You think, so what? When you start to allocate market share of the market, this story will come into play as to what type of market share you will see.

And finally, I'm going to assume that Uber will be able to continue doing what it does now, which is what? They don't own the cars or hire the drivers, which means they can grow very quickly. And they will be able to maintain that 80-20 combination. That is completely arbitrary. Why not 85-15, 90-10, 95-5? They are going to maintain that mix. That was my Uber story in June 2014. Here's my Ferrari story in October 2015, at the time of its IPO. I assumed he would stay in an exclusive club. You don't have to, right? I could pull what I call a Maserati.

Maserati in 2008 looked a lot like Ferrari, sold around 7,000 cars and had high margins. But in 2009, Maserati decided it wanted it to grow faster. The way they did it, they introduced a new Maserati, a cheaper (don't get too excited, it's not that cheap) called the Ghibli, looking for a bigger market. And he achieve it. In what sense? Its growth jumped to 15% annually. That's the good news. But what do you think happened to its margins? They went down because they had to advertise, spend. Thus they went from 18% to 14%. And besides, now you're selling to people who are rich but not super rich.

So they really knew what the economy was doing and they stopped buying cars if they felt the economy wasn't doing so well. So I'm going to assume that Ferrari will stick with its club-exclusive model and not release a Maserati. Now comes that test where... one of the most important things about stories is that the most important test is yourself. You have to make sure you ask your story the question before someone else asks it. So is it possible, plausible or probable? The reason you ask that question is probably easy to incorporate into your cash flows, right?

There are all these techniques that we can use. I may be able to generate growth, I may just wave my hands and maybe use some option pricing to generate it. But to illustrate what I mean by possible, plausible, probable, the best way I can do it is to turn it around and talk about implausible stories, implausible stories, and improbable stories. I'll give you an example of an impossible story. Each person in my class has to choose a company to value and they can choose whichever one they want. About two years ago, one of the students in my class chose Netflix to rate it.

This is a company that has a great enterprise value, exciting and dynamic, but a company where you have to work hard to get the value to match the price because it is a really high priced stock. So it trades at 1.8 and returns worth $500 per share. I am dumbfounded. Then I look at the numbers and he projects $600 billion in revenue for Netflix within 10 years. So I called the kid (he wasn't even a kid, he was 29) and I said, do you have Netflix? He said he did. I said, how much do you pay for a year? He pulled out his calculator, which seemed to be strapped to his hip.

He hits the numbers: about $100 a year. I said, how many subscribers would you need to reach $600 billion in revenue? Get this calculator out again. I said, you don't need a damn calculator. Divide $600 billion by $100, you get six billion subscribers. He says: I don't see where this is going. I said, just hang in there. I have a couple more questions for you. I said, what is the population of the world? He says, I don't know. I have to go check Wikipedia. I said, I'll save you the trouble. It's about six billion, six and a half billion. I said, is there something I don't know that maybe you should tell me?

Maybe a law has been passed that says every man, woman and child and maybe pet in every home must have a Netflix account. He says, don't be absurd. I said, I'm not the one estimating $600 billion in revenue. That is an impossible story. I will make a statement: You may not believe it, but when you look at the reviews, you prove it. One in four valuations I see, maybe one in three, of big name and bank valuations are impossible valuations, it just can't happen. It's a fairy tale. An implausible valuation can occur, but you have to have a very good explanation for it.

I will give you an example. A student of mine went to work for an NFL team, I won't name the team, and he sent me an evaluation of the team, I don't know why. So I looked at the evaluation and it had 3% growth and revenue. It seems quite reasonable until you get to know how much money you are investing in the business. And they own their own stadium and there was nothing going back into the stadium, no investment whatsoever. So I called him and said, I looked at your rating. How come you're not going to give money back to the stadium?

Doesn't it have to be maintained? He said that's easy to explain. Every time we need to renovate the stadium, this is what we do. We go to the city and threaten them. With what? We moved to Las Vegas. Are you going to fix the stadium? And works. It's an unlikely story, but if you can tell me why. So implausible stories can happen, but I'm going to turn them down and if they can give me a really good explanation, okay, that's good. And improbable stories are stories where your assumptions are at war with each other. Let me explain.

When I look at a valuation, there are three sides that I call my valuation triangle. There's the growth side, the reinvestment side, and the risk side. So help me here. If I have a high-growth company on the one hand, what should I expect to see when I look at its reinvestment? High reinvestment and usually high risk. high, high, high. OK. That makes sense. Low, low, low makes sense. You got high, low, low, I'm going to back up. And again, you may have a very good explanation for why your company has high growth and low reinvestment. You are a toll road company and have spent the last 10 years building your toll roads.

Now you're getting the growth of those paths. So you get high growth, but you don't need to reinvest because reinvestment is everything. So if it's about infrastructure, I get it now. My job in valuation is to press you on these assumptions. And if you've thought it through, you can give me a good explanation. But if you say, look, I didn't even realize that, then you have the valuation that is at war with itself. So I took my Uber story and reviewed it. It's possible? Is it plausible? It is probable? And guess what, I describe them as aurban car service company, which they are already succeeding in.

I argued that they are bringing in new users. I could use my son as an example, but I'm behaving like my mother-in-law. So I'll use the part of the country where ridesharing has its deepest roots, which is the Bay Area. Did you know that, by some estimates, the size of the car service business in this part of the country has tripled since ride-sharing companies emerged? You know what that tells you, right? That there are now people who take Uber who would never have taken a taxi, who could have driven their own cars or taken public transportation.

He's making progress. Clearly, that part of the story works too. It's plausible. The only part of the story he was unwilling to address in June 2014 was the story of how Uber could replace his second car. It's a story I'm more willing to accept today, if you live in the suburbs like I do. I drive my car to the train station every morning. It's three minutes by car, I'm too lazy to walk. I park it there all day, come back at night, get back in the car, drive it home...six minutes a day. On the weekends I go crazy, like 25 minutes on the weekend.

All in all, I have a car and pay insurance. It's crazy. But if I lived in the suburbs 10 years ago, my response would have been: what other choice do I have? It's not like you can call a car service. Uber is in my city now. In fact, in recent months I've noticed a sign that you can see from the train as you pass by and it's like every station. The sign says: Did you drive to the station today? And right below it says, take Uber. The message is not for me, I am too old to change.

But if you're 35, moving to the suburbs, instead of buying that second car, you could take Uber. This is really good news for Uber, it's really bad news for who? Automotive automobiles. We talk a lot about disruptors. The most exciting thing is what happens to the disturbed? And indeed, those companies will have to pay a price. So that's basically your verification of your story. Now I'm going to go on a little tangent here. Let's say you're tired of working on whatever you're doing. You quit and become a film producer. You move to Los Angeles. You hang out at Bel Air, the Beverly Hills Hilton, something by the pool.

And I'm going to come and tell you a story. And while I present this story to you, tell me if it's okay with you. It's about a 19-year-old boy who drops out of Stanford. Who does that? What is the acceptance rate for it, like minus 3%? Did you get into one of the most selective schools in the country and drop out? To make it interesting, let's make the 19 year old a woman. Typically, she's about a geek who drops out of school and starts a tech company. She is about a 19-year-old woman who drops out of Stanford and starts a business, but not a technology business, but a blood testing business.

This is something we all have experience with in our lives, right? We hate the way it's structured now with labs taking forever to run your tests and charging you $1,500 to take two buckets of your blood and give it to Dracula, I don't know what. She then created a business where she only needs two drops of blood in a nanotainer. For starters, that sounds pretty fancy. And 32 tests will run in 45 minutes and will be emailed to you and will cost you $50. Do you want this story to be true? Yes. These are what I call wild stories, stories that sound so good that you're afraid to ask the question.

You know, the question that will show that the story doesn't work. I wish I had made this story up because it is not a made up story. The 19-year-old Stanford dropout was named Elizabeth Holmes. The company she created was Theranos. And by mid-2015, venture capitalists had valued Theranos (again, that word comes out) at $9 billion. Some of the biggest names were on that list. And it wasn't just venture capitalists who got excited. It was the Cleveland Clinic, Walgreens. If you had asked me in mid-2015, what do you think about Theranos? My reaction, there must be some substance here, you have all these big names.

But let me ask you a question. You are investing in a blood testing company. What is the first question you will ask before investing your money in the company? It works, right? And one would assume that someone here would have asked that question. But it turned out that that wasn't true. In October 2015, a journalist from the "Wall Street Journal" decided to ask the question. And this is a question, the answers are actually in the public domain because you have to submit it to the FDA. He went to the FDA and said: Have you been approved for 32 tests?

The FDA said no. They have been approved for one of the 32. He said, why? Because the other 31, the results are too noisy. Noisy blood tests...not a feature you want in a blood test, right? Maybe you have leukemia, maybe you don't. But don't worry, we'll get back to you later, right? It's not exactly something you're going to look for. And of course the story fell apart after that. And the final pieces of the story unfold with Elizabeth Holmes being banned from the blood testing business for the next two years and Theranos sort of developing. Fugitive stories are stories where you want the story to be true so much that you're afraid to ask the question because you're afraid of what the answer might be.

I would love to tell you that if I had been an investor in Theranos, I would have asked that question. But I do not know. Can you imagine being in that room with Elizabeth Holmes saying if your blood tests work? You would have felt like the hunter who shot Bambi's mother. Have you ever felt...? I felt bad for that guy in the movie. Someone shot that... you have no idea what I'm talking about, right? This is what happens when you don't watch enough Disney movies. Go see "Bambi." Then you're afraid the answer will ruin the story and you never ask the question.

I mean, you'd be surprised how many business stories take off and continue because people don't want to ask that question. Let me go on another tangent. Sometimes I look at bank valuations just for fun, only to see inconsistencies appear. And this is the valuation of Tesla, another of my favorite companies. This is a valuation in which the analyst had projected growth for Tesla in which the number of cars that Tesla would produce would go from 25,000 in the last 12 months (this was in 2013) to 1.1 million in 10 years. Is that possible? Sure. Is it plausible? Yes, I can really tell you... because let's face it, this is a big business.

So I was fine with that part of the story. He then projected margins of around 7%, which is also plausible. So far, we're on a plausible story. Now, what is the capacity of that Fremont plant that Tesla has, 150,000, maybe 250,000 cars? So I went looking for the third piece of the puzzle: are you investing money to build more plants? And in this particular valuation, it seemed that the analyst was not investing anything in new plants. In fact, I called the analyst and pressed him and he finally admitted that he had forgotten. I made him a suggestion. I said, you know what?

The only way to get away with this is to watch "Willy Wonka's Chocolate Factory." Have you ever seen that movie, the old version? I was a very strange young person, now I am a very strange old person. I remember leaving that movie with a big question. The question was: Willy Wonka chocolates are all over the world, but there's only one factory: six floors, inefficiently laid out with rivers of chocolate running through them and stuff. And I said, how do they produce all these chocolates in this one factory? And the answer, of course, is in the movie.

It was the Oompa-Loompas. Do you remember them, magical creatures that dance and chocolates fly away? I said, this is what you should do. He put out a press release saying that Tesla laid off all of its regular workers at its Fremont plant and replaced them with Oompa-Loompas. I call these Oompa-Loompa assessments, where you have this growth and nothing is set aside to create the growth. It's not going to happen. So I have my story, I'm going to turn it into numbers. So let's start at the top. I describe Uber as an urban car services company. The total market I used for my valuation was the city car services market, which is $100 billion as of June 2014.

I assumed Uber would attract new users to that market. So this is what I did. Instead of letting that market grow at 2%, which is what it had been growing until now, I let it grow at 6%. I suppose Uber will have local network benefits in my story. The market share I gave to Uber reflected that part of the story. It was a 10% market share, huge compared to the typical car service company at the time, but not a 40% or 50% market share, which you would get if you had global networking benefits. I figured they would be able to maintain that 80-20 combination.

You'll get 20% for doing nothing, your margins will be huge in steady state. I gave them a 40% operating margin at steady state. And finally, I also assumed that they would never buy the cars, they would never hire the drivers, which means they can grow relatively easily. So what I reflected on was that for every dollar they invested, they made $5 in income. For contrast, for a typical American company, every dollar it invests generates $2 in revenue. I gave them $5. Every part of my story has become a number. If I take those numbers, the assessment takes care of itself. So when you look at the actual spreadsheet, it looks like a spreadsheet, but if you point to a number on the spreadsheet and say, why is Uber making what it is in year 10, my answer will never be, because I used 10% revenue growth for the first five years and 7% thereafter.

It will be because they are an urban car service company with local network benefits. Each number in this rating will reflect a part of my story. And if you read the numbers, we get a value. The value I came up with for Uber in June 2014 was $6 billion. What is the story that caught my attention? The "Wall Street Journal" story that said they had a price tag of $71 billion, right? So 15 minutes after posting this on my blog, I get a call from a reporter from the "Wall Street Journal." She must have just been hanging out looking for this post.

She said: I noticed the valuation you put on Uber and it got $6 billion. I said yes. He said, did you know that venture capitalists have valued it at $17 billion? I said yes. She said: How do you explain the $17 billion? I said, I don't have to do it. I didn't pay it. I have never felt the need to go around explaining what others do. So the only thing you can do in a valuation is have your story and your value. It's not my job to sell you that value. I'm not a salesman, I'm not a stock research analyst.

I'm not asking you to short-sell Uber, I'm not telling you not to buy Uber. I'm saying I wouldn't buy Uber. And I have the right to make my decisions. So my story has become an assessment. I did the same with Ferrari and that's how my club's exclusive story developed. Since it is an exclusive club, I had to give them low revenue growth, only 4% annually. Could they grow faster? Absolutely. But I can't let them grow faster in my story. The bad news is that revenue growth will remain weak. The good news is that I'm going to continue to give them these considerable margins, 18% margins.

And I'm going to give them a low cost of capital because they are selling to people who are so rich that they don't feel the effects of the economy. The value I came up with for Ferrari was 6.3 billion euros. In fact, it went public for about 7.5 billion, it danced around six billion. It's already somewhat established. But this was my story that unfolded as an assessment. Last piece and then we'll be open to questions. Like I said, when you finish a valuation, you feel pretty good about your valuation because it's your value story. And like I said, the best thing you can do is put it in places where people who don't agree with you can read it.

And I got really lucky with my Uber post because they picked it up at four very different places. The first was a site called 538. Are you familiar with 538? It's where numbers geeks go to hang out because they apply statistics and numbers to everything. It's like a money ball and everything. The second place where it was picked up was the Forbes blog. Who reads the Forbes blog? People who are geriatric investors who are basically old-time value investors. The third place where he was chosen was Tech Crunch. You know who reads Tech Crunch. And finally, the last place they picked it up was this blog called Ride-Sharing Guy.

He's a guy who writes for Uber and Lyft drivers. Actually, there are enough of them that he could write a blog just for them. I got fourvery different sets of reactions to my blog post. The people at 538 were picky. They said, why did you use a 10% chance of failure? Why not 9.96%? That's what numbers freaks think. So I said, why don't you take the spreadsheet (because I put the spreadsheet in) and change the 10% to 9.97% and see what happens? Five minutes later I get an email and now I see why you used 10%. So all those criticisms without a big picture.

The people at the Forbes blog loved it. They said, this is how you should value companies, those crazy people in Silicon Valley. I ignored the Forbes blog. There's no point in going there and getting a pat on the back saying, this is amazing. The people at Tech Crunch absolutely hated it. They said, how dare you value one of our own with your d.c.f.? We don't do that in Silicon Valley. I received this wave of abuse. And in addition to the wave of abuse, I learned some things about this business that I wouldn't have known.

I'm not a tech person, I don't want to be a tech person. I'm not a rideshare expert. Remember, I hadn't even heard of ridesharing until June 2014. So there were things about the business that I never would have known if I hadn't read those posts. And finally, from Ride-Sharing Guy, I had some very interesting things about the 80-20 combination. They said this is unusual. Uber doesn't keep the 20% because they return it. They pay us $1,500 to switch from Lyft. And you would never have found out talking to Uber's upper management, right? Because they want to preserve the illusion for investors of their 20%.

In fact, that's what they said even in the most recent announcement. They said we are still left with 20%. So how the hell are you losing $4 billion on $6 billion in revenue? The numbers don't add up, do they? And it all came true as I was sitting waiting for a flight to Munich and got an email from Bill Gurley. I knew who he was. And the email says: I read your post about Uber and I didn't like it and I wrote my own post to counter your post, a blog post to a blog post war, very new age.

He said: I have said some bad things about you. I just want you to know. I close the email. I have an hour and a half left until my flight, so guess where I'm going next? I go to Above the Crowd, which is Bill's blog, and up there he says, "Damodaran misses by a mile." Get it, Uber drives, misses by a mile. And he disagreed with every part of my story. He said Uber is not just a car service company, it is a logistics company. Words have consequences, right? Because suddenly what have you done? He's expanded his business to become car service, it's moving, it's delivery.

He said it's not just urban, it will be everywhere. He gave examples of suburban services they were going to offer. And he talked about how they were going to connect with airlines and credit card companies so that when you flew to Jakarta on United, before they took you off the plane, you would have a little Uber thing at the bottom where you could click on Uber. and I mean, when I land in Jakarta, I get... so basically, you want to connect with airlines and already have your credit card there so that the benefits of their local network become global benefits.

I was fascinated by the story. In fact, right after reading the story, I took his story and put it into numbers. And it's easy to do. The $100 billion becomes a total market of $300 billion if you convert it into a logistics market. 10% market share becomes 40% market share, $6 billion value becomes $53 billion value. And then I said, you know what? Those rideshare drivers told me that 20% is fake, so I replaced the 20% with 10% because if that's the true margin, I should put it in. And that brought the value down to about $29 billion. Are you saying, does this mean that any number will do?

No. That's not what I'd get out of this. But its history drives its valuations. If you're a new entrepreneur, the way you describe your business can make a big difference in what people leave the room willing to pay. In fact, in December 2014, I basically took this into a blog post (and you can visit it) and let people pick and choose what they thought about Uber, what kind of company it is, what kind of benefits of networking. And at the end of the blog, I basically put a list of values ​​ranging from less than $1 billion to over $90 billion, depending on their history.

And with young companies, that should always be the case. You will have big disagreements between people because of your history. And in fact, it's what, two and a half years, three years later with Uber, there's still a huge set of disagreements about what the stories are. Obviously there are people who think it's worth 100 billion dollars and there are people who think it's worth nothing. And this is what makes it so fascinating: a story in motion. As you move through this process, one last point. You finish the story, don't rest too much because the world changes around you.

Macroeconomic changes are taking place. Tomorrow's French elections could change the history not only of all French companies, but of all global companies. You have macro and micro things. Every time a company reports earnings or announces an acquisition, it changes its story, and your job, in a sense, is to include that in your valuation. And your stories can break, they can change, or they can change. Broken stories are stories where your story just explodes. An example would be Aereo. Remember the company that said they would come up with a way to stream things to your device? You could watch cable channels on your device without paying cable fees.

Sounds too good to be true, right? And it turned out that in June 2014, the Supreme Court ruled that what they were doing was illegal. Overnight, the company essentially went from a billion-dollar company to nothing. That's a pause in history. A story change is not the same story, but it may be small. I've been telling the same story about Apple for the past six years: It's the coolest ATM in history that makes almost all of its value from the smartphone business. And that business is maturing with margins that will come under pressure over time. That's the same story I told in 2012.

My assessment of Apple hasn't changed much, but the price goes up and down. And that is part of the investment. And you can have story changes, where a company convinces you that they can do things you never thought they could do. My valuation of Facebook has gone from $30 a share when they went public to almost $90 a share because every time they show me they could do things I didn't think they could do, I have to look at my story and change it. Making valuation investing much more fun is to think of these valuations not as spreadsheets and numbers, but as stories that evolve over time.

And if you're an entrepreneur, your job is to nurture that story and make it bigger over time. And if you are an investor, you should be skeptical about that story and reject it. And if you are a stranger, just observe what happens in the stories and assign a number to those stories. That's all. If you have any questions, I will be happy to answer them. AUDIENCE: I have a question about the online advertising business. Is it among the 10 worst businesses? ASWATH DAMODARAN: No. No, it is not. It's actually... you know, it's a profitable business. The only problem is that there are only two giants in the room absorbing all the profits: one is you and the other is Facebook.

For the rest of the world, it has become bad business. And you are responsible for... and your job is to make it a good business for you and a bad business for the rest of the world. And you have succeeded beyond your wildest imagination. And I think that's what... last year, if you look at the growth of this business, I think 60% of the growth came from just Facebook and Google. Therefore, it is a profitable business, but with very skewed profits. The two companies at the top keep almost all the profits, the rest don't even get the excrement from the table.

They are like Twitter, they basically have revenue but can't show profits. AUDIENCE: What about the partners we have in the ecosystem: the agencies, the marketers? Where do you think they're moving, since you said the industry seems to be consolidating around Google and Facebook? ASWATH DAMODARAN: I think they're more commoditized. They are not going to achieve the margins that they achieve. They're going to be profitable, but you're not going to let them become too profitable because if they're making excessive profits, you know what your job is, right? It is to clean it and return it to the parent company.

So you're like a mother spaceship that's essentially observing all these other little ships. You seem too prosperous, let's... so I repeat, there is nothing amoral. That's the nature of business: if you're creating value, you want to claim that value. So I think your ecosystem will survive, but the thriving mothership that you have as a company will never exist because that's what generates all that revenue. AUDIENCE: Measurement is an important part of that business, so teaching brands that online advertising is valuable, how can we do a better job of using the types of narratives that you talked about today?

ASWATH DAMODARAN: I think ultimately it's the richness of the data that convinces them. Because now you can show people what they're clicking on. I think it's easier for you than it is for Facebook, for example, because you have a search engine that people go through. It's much more direct to say: this is how you got somewhere through us. I think more and more, you'll start to see people ask questions about, oh, people click on it, but are they actually buying things on it? And as the data becomes richer, you will be able to answer the question.

And sometimes you may not like the answers you have to give...so it won't always be good news. So you will have to learn from what works and what doesn't to adapt and modify it, which you are probably already doing. AUDIENCE: My question is when doing the number crunching or forming the narrative, I guess in both of these examples I felt like the background assumed competent business and management. ASWATH DAMODARAN: Oh, I've told some horror stories too. AUDIENCE: Okay. ASWATH DAMODARAN: Read my story on Valeant. AUDIENCE: Yes. So how do you explain that Uber has a misogynistic and toxic culture or that United attacks its passengers?

How do you explain the lack of conversion that a company just can't achieve its... ASWATH DAMODARAN: That's actually a very good point. Uber has this combination of being aggressive: it has always been an aggressive company that has broken every rule in the book and done it. But in a sense, it is also its greatest weakness. In fact, the best way to see how this plays out is to have a story about Lyft in the book. And if you think about Lyft, I describe Lyft as you know in bike racing, if you're a racer, do you really want to be behind the lead racer because he or she picks up the wind resistance?

Lyft is like the rider behind Uber. So Uber is the one who does the wind resistance, goes after the regulators. Lyft says, we're the good guys, we're the good guys, we're the good guys. It's actually a different and interesting story, right? It is a much less ambitious story. It's a story where you keep your head down and say: we are the good guys. And they are going to do things in a very striking way to show that they are the good guys. You saw it in the last few weeks, right? You are the bad ones, we are the good ones.

It's actually interesting, but the good guys don't always win in these stories. I think the other thing is that sometimes this toxic, aggressive culture could be what ends up winning. So unlike soap operas, where you can make the good guys win, sometimes the bad guys win in these stories and that becomes part of the value of the business. So in that sense, justice doesn't always prevail and morality doesn't always prevail. It's investing, right? But I do tell stories about... I mean, I don't enjoy them as much... about companies that are horror stories. I mean, I've been telling the Valeant story for the last two years of a company that fell from grace, right?

It's a Cinderella story in reverse. It starts with this: you start in the castle and end by cleaning the chimneys. And I think it's sometimes fascinating to watch horror stories unfold because you can see the psychological and behavioral issues that influence these assessments. SPEAKER 1: One of the questions concerned a company that in its blog posts calls the "Field of Dreams" company. The thing is, as you grow revenue, the profits may show up, they may not show up, but the cash flows are there. And a lot of that is still driven by changes in working capital. So for those of you who don't know, I'm talking about Amazon.

The question is, how do you see a company like this and what do you think of it? ASWATH DAMODARAN:You know I call it the “Field of Dreams” company, right? Have you seen "Field of Dreams"? Kevin Costner builds this baseball field in the middle of nowhere and people ask him: Are you crazy? Why are you building a baseball field in the middle of nowhere? And remember what he said, if I build it, they will come. To me, that's... when I think about Amazon, that's the message that Jeff Bezos has been sending since day one. If you get a chance, check out the letter Jeff wrote about Amazon in 1997.

Do you know where I found it? I found it on Google search, so you can find it too. It's actually an incredible letter because it describes what he was going to do at Amazon. He said that at Amazon we are going to look for revenue first and then once we have generated the revenue, the profits will come. That's the story told in '97 and he's been telling the same story for 20 years. And he has acted in a manner consistent with that history. Do you know what I mean by acting consistently? How many people here have Amazon Prime?

What do you pay for it? $99. Do you know how much it costs Amazon to service each Prime member? About $400. That's crazy, why would you do that? If you build it, they will come. What are you building with Amazon Prime? It's building this block of Amazon-addicted consumers, for lack of a better word, who don't even know what a retail store is like anymore. And one of these days, he will come for you. So don't be surprised if a third nine appears after the first two nines and you have nothing to do, because where are you going to go?

Everything else will have closed by then. So the conspiratorial view about Amazon is that it's building a business that will ultimately get you. And that explains the $700, $800, $900 per share. The problem is that it is a business where it will be difficult to keep out newcomers and new ways of doing business. So the challenge here is what if that doesn't happen? Well, you could end up increasing revenue and never being able to turn a profit. So it's, again, a fascinating case study in how to tell a consistent story. Because people often say that markets are short-term. You probably heard that in Silicon Valley.

What short-term market would allow a company to go 20 years without making a profit and still grow its market capitalization? To me, Amazon is the perfect counterexample that if you can tell a consistent story, the markets will give you a lot of slack. Do you know why they don't do it in most companies? Because history keeps changing every year. Senior management is unable to tell the same story over time and then the market says: we don't trust you. So the other lesson that I think is learned from Amazon is that if you're building a business, you're telling a story, don't keep swinging like a weather vane toward whatever works.

You have to have a coherent story, you have to act coherently with that story. And you'll be surprised how much slack is reduced because of that. SPEAKER 1: Professor, before we move on to a specific question, there is a question that we generally ask all the guests, and this is not only for this audience, but also for your audience on YouTube. You have written this fantastic book, as well as others. What are some books that you have found useful that are generally underrated? ASWATH DAMODARAN: Generally underrated. I thought you were going to ask me what my favorite book was because I was going to reveal to you my roots in number crunching and that my favorite book is "Moneyball." That tells you where I am, and I think it is, but I think in terms of underrated books, I think I learn a lot more about valuation investing from non-trading books than from trading books.

Again, it's about storytelling. I need to develop my narrative side. I don't know if you've ever read, there's a book written by a member of Pixar. It's a book that I love because it taught me things about storytelling that I didn't know, things...because let's face it, if I can tell a story like "Toy Story," I'll be able to sell amazing businesses, okay? So I read different things. I read fairy tales, I read... I mean, I love serial killer books because they always end badly. But I think, in a sense, I get my stuff from all kinds of different places.

AUDIENCE: So there are some companies that need outside capital at the beginning, like Tesla, right? For those companies, they are actually more valuable if they are priced higher because the equity will be very low, right? If its price is $2 trillion, if shares are issued very cheaply, they will get whatever money they want. And it also applies to real estate investment trusts. How do you put that into your rating? ASWATH DAMODARAN: Okay. The first thing to remember is that the price is not set by you, but by the market. So if you can get them to offer you a high price, it will make your life easier.

I mean, you hear this word cash burn in Silicon Valley all the time, right? Cash burn basically means that you have negative cash flows from the beginning because you need that cash flow to grow. And you have to spend cash, you need capital to cover the cash flow. You cannot survive as a company. And if its price is high, the advantage is that you can get that capital at a very advantageous price. So this is, in fact, what happens. For these companies, there's actually an incentive to tell really big stories early on, because great stories command great prices.

The price then allows you to cover the capital. At some point there will be disappointment because people will say, well, that story was never going to work. And then all kinds of disappointments arise. It may be too close to home, but has anyone heard of Juicera? I was reading the story about Juicera and I said, what kind of story would you need to tell me to invest in it? How many people would pay $400 for a juicer? I mean, it's a very small market. So if you were telling that story and I assumed a market of 50 million Americans buying, it's a story that doesn't work.

But if you could expand the story, you would increase the prices. It allows you to raise capital to cover your cash spending needs. So that's something to remember. I don't think that's Elon Musk's reasoning. I think he just likes to tell really big stories and make them bigger over time. But I think for some startups, part of this is a game. If you can increase your prices, it will actually make it easier. It greases your skids while you spend those first few years of cash. SPEAKER 1: Don't hit me for asking this, I'm just the messenger here.

How do you decide when there was something wrong with your value estimate and the divergence between price and value holds for an extended period? What are some examples you can share with us? Could you talk a little bit about your investment in Valeant and Twitter, etc.? And again, I'm just the messenger. ASWATH DAMODARAN: Like I said, one of the things I find that gets in the way of good investing is that I tell people the three words they should be able to say openly when investing: I was wrong. Because once you say that, you free yourself from your own story.

Because as long as you're not willing to say that, you'll find ways to accept your old story that it's not wrong, that this part is someone else's fault. I have absolutely no qualms about accepting the fact that I'm wrong and sometimes I'm terribly wrong and it's not my fault. That's what allows me to get away with it. It's not my fault in the sense that things happen around me that I can't really control. So when I make a mistake, I have to see what part of it was my fault and what part of it is out of my control.

With Valle, this is what happened. I bought Valle and Brazil went to hell the year after I bought Valle. You say, why didn't he predict that? If I could have predicted it, there were much easier ways to make money than shopping; could have shorted Brazilian bonds. I was out of mental control. I call this the karmic moment in investing. You've heard of karma, right? Basically, karma means that there are some things that are going to happen, nothing you and I can do can change that. We have to accept that I was wrong in Valle, but I couldn't have done anything about it.

With Valeant I was wrong and it was partly my fault. And this is what I missed in Valeant. For those of you who are not familiar with Valeant, Valeant built its reputation as an unusual pharmaceutical company by acquiring other pharmaceutical companies and doing something that is morally and ethically questionable. They would take low-priced drugs and change the price. You know what that means, right? So you're a company that's in a... let's say it's a heart drug that exists, has been on patent for eight years. They are charging $50 per dose. It only serves about 7,000 people. And Valeant said those people will pay $5,000.

They need it to live. Prices went up. They did incredibly well for a while. But that story was a story that worked only as long as they stayed under the radar, right? Because this isn't exactly a story you're going to tell openly: We buy other companies, we take their drugs, we increase the price by 50%, 500%, 5000%. So when Valeant fell apart, it was because they became too ambitious. They got too big. They bought Salix, an $18 billion company. When they tried to raise the price of medicines, people took notice. And the moment that happened, the whole company fell apart.

It fell from $200 to $32. And I bought it at $32 saying, look, there's still enough value in the company. You know, what I missed is that this company caused so much damage to their reputation. We talk about corporate sustainability. It taught me a lesson about why corporate sustainability has a place at Valeant. They had done so much damage to their reputation that no one trusted them. Because I assumed they would become an old-fashioned pharmaceutical company. But to become an old-fashioned pharmaceutical company, what do you have to do? We have to build an R&D department, we have to hire scientists.

Let me ask you a question. You are a scientist, I am Valeant. I come and say, do you want a job at Valeant? What is your reaction? I've heard about you, I won't go there. That is why they are having problems developing their business. They are trying to sell part of the business. I'm Valeant, I'm trying to sell you a part of my business. What is your reaction? You are liars. I don't trust anything you do. So what I missed in the Valeant case is the damage they had done to their reputation, making it almost impossible for them to be a going concern.

That damage cost me 60% of my investment in Valeant. But it's a lesson I can use when I think about other damaged businesses. So would you buy United after the $1 billion? Maybe. This is why. It's a broken company, but it's in a business where everyone is broken. If it weren't for the grace of God, Delta would go there, right? Don't assume Delta wouldn't have dragged you along. Maybe they would have dragged you a little more carefully, okay? This is a business, and that's why I bought Volkswagen after... because I looked at Volkswagen and said, hey, do you think only Volkswagen does this?

Everybody does. You have knocked down the value of Volkswagen by 24%. So it's a game I've played before. But in the case of Valeant, I got this warning sign that sometimes a company can cross the line so far that crossing it again will be really difficult. And the other thing is that a mistake will cost you a lot less if you don't put half your money into the mistake. So this is really a rejection of what you sometimes hear from value investors: don't spread your bets, buy four big companies. I have never believed that advice. It's arrogance to think that you somehow have these four winners forever.

So for me, the reason I keep any investment I make to 10% or less of my portfolio is because I know I can make mistakes and I have to be aware of that. SPEAKER 1: What are your typical positions always like? ASWATH DAMODARAN: I would say, going in, about 5%. If it does well, it will reach 10%; If it goes badly, it takes care of itself, it's out of my wallet. So Valeant is no longer 5% of my portfolio. So what I really have to watch out for are the stocks that get good results. And in fact, with Apple this will unfold over a 15-year period because I bought Apple in 1998 and I bought it as a charitable contribution.

Because I loved Apple so much. It seemed like it was going to close and this was going to be my last contribution, look how much I loved you. Here, take the $14. It turned out to be the best investment I ever made. Sometimes it shows you that your best investments don't come from all your intrinsic value, but from your charitable contribution. The problem with Apple is that it did so well that it kept hitting that 10%. I left about half the profits I would have made with Apple on the table because I had to keep selling. And I don't regret doing it because that's what I need to do to be disciplined.

And one of the things I discovered is that if... the way I do this is I automate it. Do you know what I mean by automating it? I have limited sales on each investment in my portfoliothat I have done before it happens. Because if I wait for it to happen and then say, should I sell it now?, I find delusional ways to say, this time is different, this stock will continue to go up. So sometimes you have to realize for a long time that you can't trust yourself. Basically, you need to automate the process to take it off your hands.

SPEAKER 1: We were talking earlier about your limit order on Apple, and I think it would be good for the audience to share some of that conversation. But I found it very interesting. You then had an estimate of the intrinsic value and once it was reached, the limit order for Apple was executed. My question to you was: if the price drops below that price, will you buy again? In other words, how do you think about or quantify the margin of safety and how do you differentiate buying and selling? ASWATH DAMODARAN: When I bought Apple, I was lucky.

I bought Apple at $94, put a sell limit at $140 and it ran, so Apple was out of my portfolio. I've bought Apple four times and sold Apple four times in the last six years. Because? Because my value remained stable, but this is what happens to Apple. A new iPhone comes out, income increases by 8%, people start dancing in the streets. It is a growing company again. They raise the price too much and then four quarters later their revenue drops because the iPhone is aging and people are convinced this is the end, they sell Apple. So it's almost like you take advantage of a manic depressive, which is what the market is: manic, I sell to him, and he's depressed, I buy from him.

However, my general rule of thumb when investing is that I want to buy when I feel a stock is undervalued. And when I value a stock, I get a point estimate. But that's, again, arrogance, right? Because I made assumptions. Revenue was supposed to grow 7%. But if you pressed me, I'd say, well, you know what? They can probably grow between 5% and 9%. That's why in recent years I've started using Monte Carlo simulations in my valuation, in part because it forces me to be honest about my uncertainty and then forces me to be specific about my uncertainty. And I get a value distribution, which becomes my basis for deciding when to buy.

So I'm not going to buy Apple when it drops to $139. My value is $140. It went down to $139, I'm still with... if you look at this distribution, I'm very close to my expected value. So having a distribution, I can look for a trigger point and say... and I have to configure the trigger. It has to be at least 80% undervalued for it to take effect, which would be equivalent to between $124 and $122 for Apple. That becomes the basis on which I think about both buying and selling in terms of distributions, not in terms of point estimates. SPEAKER 1: So do we have a live question from the audience?

Yes. AUDIENCE: So this actually echoes... I guess you mentioned a Monte Carlo simulation. I actually did a Monte Carlo simulation for my PhD and part of my feeling is that all the assimilation (simulations, number crunching, storytelling) is assumptions, right? And it echoes the uncertainty, the prediction part that you're talking about. At the end of the day, how do I know I made the right assumption? ASWATH DAMODARAN: The word he used was know. You never know. And that's something that... and I said that one of the biggest problems that those who do numerical calculations have is a psychological barrier that you have to overcome, and that is that we are so used to at the end of a math problem to check the answer and say, I know I did it right.

Look, I can check it. That's why accounting is much more convenient than valuation, right? The balances have to be balanced. It's balanced, I'm done. The problem with assessment is that you finish an assessment, look at it and say: how do I know I'm right? I'll tell you the answer, you won't. And you have to be okay with that. There is no confirmation mechanism that can offer you. That's why I used the word faith. What is the essence of faith? Why do you go to church every week or temple every week? It's because you have faith that God exists.

You say: prove it to me. May I try it on. The same applies to investing. If you ask me, show me that valuation works. I don't have proof, I have faith. And I cannot transmit that faith to you. So when I teach my valuation class, I tell people that at the end of this class you have to decide for yourself if this works for you. I can teach you how to value a company, but I can't give you faith. That has to come from within. Maybe you will develop faith, maybe you won't. And if you don't develop faith, it's not the end of the world.

You can buy ETFs and index funds and you will be perfectly satisfied. And here's my definition of faith, and it's going to sound morbid. I ask people who are active investors, let's say you reach the age of 85, you're on your deathbed (I told you that was a morbid thought) and I come to you with some statistics. I say, look, for the last 60 years, you've been doing valuations and picking stocks and you've earned 8.13% a year. This is cruel and unusual for someone on their deathbed. And then I say, you know what? If you had invested your money in ETFs and index funds over the past 60 years, you would have earned 8.22%.

So you've spent 60 years of your life researching two hours every night and you've basically made less money than you could have invested just by investing your money. Would you agree with that? And if your answer is no, I tell people not to actively invest. I'd be fine with that. You know why? Because I enjoy the process so much that even if at the end of the game you told me that you're not going to make money from this, I would say, I'm fine. I had a lot of fun doing it. And that's, to me, part of the reason why storytelling works is that if I was just going through spreadsheets, I'd go crazy.

Because when you do spreadsheets, you want affirmation... I did all this hard work, I tortured myself. I need to be rewarded. And the market says: no, you don't need to be rewarded. I'm going to take 20% off. And your neighbor, who picks stocks based on astrological signs, makes millions. You say this is very unfair. It is the world. Unfortunately, there is no way to know. But that's the part about faith: it may come or it may not. But it has to come from within. AUDIENCE: And a quick little follow-up question is, when we look at valuation, how do we learn?

For example, if the numbers match my prediction, does that mean I did a good job? How do I know which part is my job and which part is not? ASWATH DAMODARAN: This is what I tell myself. When I pick a stock and it goes up, the first thing I say is that I got lucky. And then I say, Okay, maybe I did something extra because luck is the dominant paradigm in this business. There are so many things that are out of your control that you really can't do much about. And it helps you on both the positive and negative sides.

That's why I can be optimistic about stocks going down: you can't be selective. And this is what behavioral finance discovers: when something works, you want to claim the credit yourself. When something doesn't work, what do you do? You blame the rest of the world. I mean, when I talk about taking ownership of your investments, I mean taking ownership of both sides of the investments. Therefore, we must behave exactly the same when we win and when we lose. And that's really hard to do. I have to work hard to try to do it and it's not easy for me.

SPEAKER 1: You have written about Facebook, about Amazon, about Apple. Traditional value investing has generally put technology in a certain light because of the risk of, I guess, innovation disruption and all that. Do you think that has changed over time and that value investing in technology works well? ASWATH DAMODARAN: It should change. And I think part of the problem is that we now use the word technology to refer to this very diverse set of companies. In the 1980s, if you had said technology, I would have said young, high growth, risky. Today when you say technology, you are talking about 22% of the market.

And you're talking about companies that span the entire life cycle spectrum. Intel is technology, but so is Facebook and Snap too. But what do they have in common? One is a company that, I mean, isn't exactly walking dead, but if you think about Yahoo, you can have walking dead tech companies that are essentially facing the exit and you can have growing companies. A couple of years ago, I took all the US tech companies and broke them down by age. I took the founding year and then looked at the metrics by age. And technology companies age in what I call dog years.

Do you know what I mean by dog ​​years? A 20-year-old technology company is like a 140-year-old manufacturing company. Because the old... if you look at GM and the time it took GM and Ford to go from a startup to a mature company, it took them 60 years. They stayed in that cash cow situation for about 30 years and then went into this long-term decline. A technology company, if you look at it, the growth that took 60 years is achieved in eight. That's the good news. The bad news is that you don't have much time to have fun as a source of income.

And then when you start to decline, the fall is precipitous. So if you think about life cycles, the life cycle is a much more pronounced lifestyle. So in technology companies, I think we need to stop talking about technology as a collective space and think about some of the best deals in this market that are in the old technology space. I mean the Microsofts, the Intels. These are dairy cows. Can it be interrupted? Sure. Also GM, Ford, Coca-Cola and McDonald's too. What makes us think that just because you have a consumer products company I can't upset you?

Disruption is part of this process. So to me, ignoring technology because you think it's too risky means you're at least 75 years old. Because we have frames of reference that come from the 1980s and 1990s that people still maintain. I was glad when Warren Buffett finally bought Apple because it's a small step, but for a long time his view was that I don't buy technology companies. In fact, his opinion was that I don't buy anything I don't understand. And that basically means that 80% of the world will come out of the domain if that's the definition of it of not being able to invest in things.

So I think we should start dividing technology into old technology, middle-aged technology, and young technology. SPEAKER 1: This is a little bit more about accounting because you've written a lot about accounting. ASWATH DAMODARAN: I say very nasty things about accounting, so I hope I don't have to say them. SPEAKER 1: Well, you still get invited to events and to give

talks

, so I hope everything is okay. But you've written about reinvestment, growth, and return on capital, and how they're related, and you talked about that in your talk as well. The question is about definitions. When thinking about return on equity, equity can be defined as equity plus debt minus excess cash.

Some people define capital as tangible capital that is used to operate the business. What really drives capitalization? Is it tangible capital and returns on tangible capital or is it how you define it and I guess what I'm asking is what is the difference between the two approaches and how do you make sense of it? ASWATH DAMODARAN: The first thing is to stay away from the accounting definition of all these things. And let me explain what I consider reinvestment. You want to grow as a company. The question I want to ask you is what do you have to spend money on to grow?

When I ask a manufacturing company that (what do they have to spend money on, new factories, new plants, new equipment) and old accounting catches with capital spending. If you look at a pharmaceutical company, what do you invest in to grow? R&D. And what do accountants do with that? Screw it up big time, right? They treat it as an operating expense. And if you ask a company like Google what it has to reinvest to grow, you can already see that accounting definitions won't capture what it invests money in to grow. You may have to grow by buying young technologies because that's what you need to bring to the space.

So one of the things we need to do is stop focusing on what accountants call capital expenditure. Because that won't capture what I want to call capital expenditure in a company like Google. Because that's the only way to be rational in how I value these companies. If you are a consulting company, what do you have to invest in to grow? Human capital. So those recruiting and training expenses that you have, at least some of them should be treated as capital expenses. So my definition of capex is not going to match an accountant's definition of capex because my definition of capex is based on how fast you want to grow and what you need to invest money in to achieve that growth.

SPEAKER 1: The same goes for capital, like tangible capital versus... ASWATH DAMODARAN: Same thing. Once you make that definition. My capital invested in a company like Google will require me to capitalize R&D, right? Because if you invest money in R&D and I do what accountants do, it will never buylike... SPEAKER 1: What about goodwill and non-operating assets and things like that? ASWATH DAMODARAN: Goodwill is a useless area. It's the most dangerous variable ever created because it shows up when you do procurement and accounting... it's a pluggable variable. SPEAKER 1: Then you wouldn't tell it. ASWATH DAMODARAN: I wouldn't count it as part of invested capital, simply because it could be maintained consistently.

Because goodwill captures future growth, it captures stupidity, it captures the premiums you're paying. Capture everything you do above that book value. So for me goodwill is not an asset, right? SPEAKER 1: Good. Thank you very much for indulging us with our questions and your valuable time and chat. Thank you so much.