Key things to keep in mind while investing during a crisis

– Prof Damodaran has been teaching for four decades and his experience across multiple crises is that three things happen to most market participants - you lose perspective, you lose faith in fundamentals, you start reaching out to experts outsourcing your thinking. He said it’s important to get out of “that morass” as an important first step.

 When faced with complexities and large uncertainties, it is a natural tendency to clutch at some heuristics or rules of thumb. Invariably these are sources of biggest mistakes. Instead, be calm, go back to first principles, examine the assumptions & narrative behind the assumptions, and most importantly have confidence in the valuation framework.

 Sanity check using reverse DCF – While it is one thing to project one’s narratives to arrive at a range of valuations, it is equally important to see what the market is trying to tell. The most important aspect of reverse DCF is to first decide on the variable which is the most uncertain and can have the biggest bearing on the narrative. (e.g. Operating Margins for instance, in the case of Tesla)

 Company longevity and the need for flexibility in the DCF model – this was one of the fascinating slides in his master-class where Prof classified all global stocks into deciles, from their age since incorporation. And the verdict from the COVID crisis seems to suggest that the market seems to believe that younger companies plausibly have better odds of adapting to the post COVID world (not very different from a health angle, where COVID seems to take its toll more on older people). Prof made the case for how while 20th-century businesses had a slower ramp to growth and mature and then a long tenure of predictable cash flows before the ultimate decline, current business models have a faster ramp to growth, have a short phase of supernormal profit pools and disappear equally fast. From the DCF construct, he went on to explain how 21st-century businesses potentially may need to consider negative terminal growth rates – a construct that I had never considered. It would be interesting to see what VC professionals have to say on this front.

 Labels don’t matter – It is fashionable to label and slot investors to ‘growth’ vs ‘value’, ‘fundamental’ vs ‘quant/technical’, ultimately there is no difference in the first principles methodology of valuing companies. This possibly explains why the Prof easily finds value in a lot of tech businesses – an anathema for many “value investors”.

 Valuation in a low-interest world - Prof Damodaran addressed questions on whether the low-interest regime was distorting valuations quite eloquently, where he tied in the fact that while interest rates are low, they also mean we are inherently in a low growth environment, and hence while discounting factor may get a bump up due to lower interest rates, the terminal value growth rates also need to reflect the low-interest-rate environment. In a sense, this to me, explains why companies that are demonstrating predictable growth rates have seen rerating in such a low-interest-rate environment compared to older businesses where the market seems to have question marks on the terminal value of the franchises.

 Monte Carlo Simulation – While this seemed like a nice gimmicky feature we had in our B-school courses, as a practitioner I think we are obsessed with forecasting earnings estimates etc, that we sometimes forget that investment is a probabilistic endeavor. Markets, underlying businesses are non-linear and therefore, it is important to see the distribution patterns of the assumptions we enter and the distribution of the output expected range of valuations. Else, it is always GIGO (Garbage In Garbage Out). One excel add-in that I intend to explore further in this regard is Crystal Ball.

 There is a duality in the investment profession – Art & science, luck & skill, numbers & narratives. Anyone who has seen market cycles will easily tell that obsessing one over the other leads to disappointment, sooner than later. Sharpen the weaker link, to restore balance over time.

 “I don’t know” – This is a common trait of people I have found who are on top of their game, which is their humility to lay it upfront on which are the aspects they don’t know about. Respect the feedback loops of the market, rather than live in one’s own world and believing the rest of the world is crazy – was a very powerful message that Prof delivered.

 Intellectual integrity – He offered some powerful advice to younger students and practitioners, from Hamlet – “To Thine Own Self Be true”. There will always be conflicting objectives driving decision making in the real world, but at the end, one has to be true to oneself. He has demonstrated this throughout his career with his fearless commentary on various market topics!

A good conversation with a great teacher leaves you reflecting for a long time afterward and unpacking the insights and rethinking one’s beliefs and biases. This truly magical 90 minutes with the “Dean of valuations” was a conversation I will always cherish and learn from!