The Corporate Life Cycle: Insights from Aswath Damodaran

Professor Aswath Damodaran, known as the "Dean of Valuation", recently joined the Meb Faber Show podcast to discuss his new book "The Corporate Life Cycle" and share his insights on valuation, markets, and investing. As a professor at NYU Stern School of Business teaching corporate finance and equity valuation, Damodaran brings decades of experience analyzing companies and markets.

The Corporate Life Cycle

Damodaran's new book examines how companies evolve through different stages, from startup to maturity, and how this impacts their financial characteristics and valuation. He notes that understanding where a company is in its life cycle is crucial for investors:

"If you tell me where you're in the life cycle I can pretty much guess what kind of debt mix you should have and how much you should be returning. But in practice companies fight aging - they don't want to get older, they want to be young growth companies."

He argues that many companies try to act younger than they are, refusing to return cash to shareholders even when they lack good investment opportunities. Damodaran advises companies to "act their age" financially:

"It's amazing how much healthier companies become if they accept where they are in the life cycle and behave accordingly."

He points to Meta and Alphabet recently initiating dividends as a sign they are maturing:

"Paying dividends for a company is like waking up one day and throwing out your cut off jeans and wearing khakis. It's basically saying 'Hey, I'm a grownup, I have a job to go to, I can't do what I used to do.'"

Valuation Approaches

As an expert in valuation, Damodaran shared his approach to analyzing companies:

"One of my advantages is I don't value companies because I'm interested in investing in them per se. I value companies because I'm just interested."

He focuses on companies facing challenges or shifts in their business model to understand if the issues are temporary or signal deeper problems. For example, he recently analyzed Starbucks:

"The case of Starbucks - it's a storyline that broke. The storyline that Howard Schultz used to make Starbucks the company that it was, was 'We'll all gather in these neat little coffee shops and drink not just coffee but buy all that Starbucks stuff and hang around.' That was broken by what happened after COVID where online ordering became the rule rather than the exception."

Damodaran emphasizes the importance of understanding the story and business model behind the numbers when valuing a company.

Views on Current Markets

When asked about current market valuations, Damodaran cautioned against relying too heavily on metrics and approaches developed for past market conditions:

"One of my concerns with so much of what we take as conventional wisdom in investing is much of it comes from the US in the 20th century. That price to book study, price earnings - you look at the Fama French studies and you're saying so what? The US in the 20th century was the most successful mean reverting market of all time."

He argues that traditional value investing metrics like price-to-book ratios have lost meaning for many of today's largest companies:

"Book value, which is at the core of so much of what we do in traditional value investing, has kind of lost its meaning. It's lost its meaning because the largest companies in the market are technology companies, pharmaceutical companies, where accountants have no idea what to call book value."

Instead of relying on simple metrics, Damodaran focuses on understanding business models and competitive advantages. He looks for opportunities in growing markets, giving the example of healthcare in India:

"Half of all India probably have never gone to a doctor, forget about getting healthcare on a regular basis. They've never gone to a doctor because they can't afford it. You get a billion people going to the doctor, there's going to be a huge demand for healthcare in India."

Thoughts on ESG and Corporate Governance

Damodaran shared critical views on the current state of ESG (Environmental, Social, Governance) investing and corporate governance practices. On governance, he focuses on shareholder power:

"When I think about governance I don't think about it from the check box of do you have an independent board, how many directors. My focus on governance is how much power do shareholders in this company have to change the way the company's run if it's not to their satisfaction."

He argues that dual-class share structures, where founders retain outsized voting power, undermine good governance. On ESG more broadly, Damodaran is skeptical of its effectiveness:

"ESG has never been about governance. In fact, it's the exact opposite of the governance we want where managers are accountable. It makes them unaccountable."

He contends that ESG metrics are poorly defined and easily gamed by companies:

"You're starting with a fuzzy measure, you're not sure what you're measuring, and then you extrapolate from that actions you want companies to take to improve that measure. You created a gaming model."

Ultimately, Damodaran argues ESG has failed to deliver meaningful progress on the issues it claims to address:

"Take every one of the big problems that ESG claims to be aimed at solving, right? Whatever it is, whether it's climate change or whether it's racism or whatever it is - 16 years after ESG came into play, ask yourself on any of those problems are we better off now than we were 16 years ago? And the answer is absolutely not."

Investing Philosophy and Advice

Damodaran shared several key pieces of investing wisdom throughout the conversation. He emphasized the importance of humility and avoiding overconfidence:

"I'm not righteous expecting to be rewarded for doing my homework or trusting in value. In fact, I made peace with the possibility that at the end of my investing life I could look back at the returns I've made and conclude I could have done as well or better investing in index funds."

He advises investors to take ownership of their decisions rather than blaming others:

"Far too few investors take ownership of their decisions. They want to blame somebody else - they want to blame you as a fund manager, they want to blame Goldman Sachs because it was an equity research report, or Jim Cramer because he yelled out the name of the company. Ultimately when you buy there's nobody to blame but yourself."

Damodaran also highlighted the challenges of selling investments, noting that psychology often leads investors to hold losers too long and sell winners too early. He shared his own approach of sometimes selling partial positions to manage regret:

"I sold half my Nvidia. This way if Nvidia continues to go up I can point to the half that I hold on to say I did the right thing, and if Nvidia goes down I can point to the half that I sold. It's completely playing mind games with myself, but I need to do that to be comfortable as an investor."

Ultimately, Damodaran emphasizes focusing on the process of analyzing companies rather than short-term results:

"If you enjoy the process of understanding companies and you invest on that basis, you take ownership of your decision... You did your homework, you bought the company. If you make money great, if you don't make the extra money you did, you're still okay because the process is what led you to this final choice."

Conclusion

Aswath Damodaran's insights on the corporate life cycle, valuation, and investing philosophy offer valuable perspective for investors. His emphasis on understanding business models, avoiding overconfidence, and focusing on the process rather than short-term results provides a thoughtful framework for approaching markets. As the investment landscape continues to evolve, Damodaran's willingness to question conventional wisdom and adapt his approach serves as an important example for investors seeking to navigate an uncertain future.

Article created from: https://www.youtube.com/watch?v=GzKq_p8IKqI