. I came away with my study of intrinsic value with the following conclusions. These numbers are not nearly as subject to accounting tricks as the others. Aswath Damodaran has, as far as I know, not made millions by investing in stocks whose intrinsic value is far higher than their market value. Then we’ll take that as a percentage of these companies’ total market cap (shareholder yield). We throw almost all decisions into the too hard pile, and we just sift for a few decisions that we can make that are easy. As for those companies in “infancy”—companies with very few years under their belts, high sales growth rates, and negative projected shareholder yields—I would venture that trying to estimate their intrinsic value is a fool’s game. I’m a dabbler. We try to figure out how much the object will be worth in a year’s time, or two years, or ten years, and discount that amount back to the present time. ‘Dean of Valuation’ Aswath Damodaran on FAANG Stocks, the Economy, and Companies Worth Buying “Over the long term, I think winners and losers will be seen more in terms of sectors rather than countries,” asserts the NYU business school professor. And if you’re looking for an ability to correctly value all investments at all times, we can’t help you.”. A young company will have high sales growth; a mature company will have low sales growth. ... (Aswath Damodaran) approach of using the sales to capital ratio to estimate the required net capex to support revenue growth. I am a professor at the Stern School of Business at New York University, where I teach corporate finance and valuation to MBAs, executives and practitioners. To report a factual error in this article. This lends itself well to a three-stage growth model. It’s those companies whose intrinsic value is greater than twice their market cap that you want to seriously consider investing in. Everything else—profitability, return on capital, earnings growth, free cash flow generation, asset turnover, accruals, and so on—are simply the steps between those two. Weekly evaluation of thousands of stocks based on sound financial metrics. Earlier this week, New York University business professor Aswath Damodaran criticized the initially proposed IPO price range of $17 to $19, describing that … Trying to come up with an automated way to calculate intrinsic value is probably not a great idea. Now what really happens is that g starts off at one number and then changes. Companies in the first stage are almost impossible to assign an intrinsic value to, but using a two-stage valuation process for the others can give you an approximation of what they might be worth. So let’s take all mature companies—companies with fourteen or more years of annual reports—and find out what they’re actually returning to shareholders (shareholder payout). The only way Tesla (TSLA) can be valued at twelve times the market cap of Ford (F) is for us to assume that in ten years’ time Tesla will be (by some measurement) twelve times as big as Ford—whether that means twelve times as profitable or generating twelve times the revenue or producing twelve times the number of cars. Moreover, the conventional methods of estimating intrinsic value simply haven’t worked lately. Including debt reduction is quite problematic, as debt has significant tax benefits and its cost is far lower than the cost of equity, so mature companies very often increase their debt rather than reduce it. definite and ascertainable, cannot be safely accepted as a general premise of security analysis. It’s hard to draw conclusions from numbers like these. So we can say that the discount rate should be 6% plus the US ten-year treasury rate. As to whether having a large MOS is a net plus or minus depends in large part on whether value investors can afford to be picky. Sticking to revenue and shareholder payout brushes all that aside. NYU Business Professor Aswath Damodaran Just 15 months later, Uber is reportedly on the verge of raising another $1-billion venture round in which it would be valued at up to $70 billion. You can see it here. I have been at NYU since 1986, and was elected as the most popular business school professor in the US by MBA students across the country in a 2011 survey by Business Week. I now had aggregate shareholder yield. All these factors are of great value, and if you’re serious about calculating intrinsic value, you’ll take them into account somehow. Then. As I said at the outset, doing intrinsic value by an automated method, which is what I’ve done here, is almost certainly not going to make you wealthy. Because EBITDA and old-fashioned cash flow are very highly correlated with (in other words, very similar to) operating income but inferior in fit, we can eliminate those, leaving us with five significant data points in predicting shareholder payout. And that’s a comparative process. Investing in a tech stock is riskier than investing in a utility, so the discount rate should be higher. It also explains why conventional measures like P/E and price-to-sales and price-to-book tell us very little when used on their own, without any consideration paid to growth potential. Once again, this is a very, very rough calculation, and should be used for overall data purposes rather than figuring out the sales growth of a particular company. So I would conclude that using an overall discount rate of 6% plus the risk-free rate is likely wiser than using sector-specific rates. All Rights Reserved. The difference between them is small, but not insignificant. I have an active presence online, on Twitter (@AswathDamodaran) and with my website (http://www.damodaran.com). Among her predictions: Elon Musk's car … Just as there are five components to predicting shareholder payout, I recommend looking at five margins: gross margin (gross profit to sales), operating margin (operating income to sales), net margin (net income to sales), cash flow margin (operating cash flow to sales), and shareholder margin (shareholder payout to sales). . Does valuation have to be so complicated? The essential thing to examine is a company’s margin and whether it is likely to increase. The most underpriced companies in the S&P 500 are, according to my calculations, Centene, Amerisource Bergen (ABC), BorgWarner (BWA), ViacomCBS (VIAC), Best Buy (BBY), NRG Energy (NRG), McKesson (MCK), Humana (HUM), Cardinal Health (CAH), and L Brands (LB). This is calculated as the net change in revenue divided by the net capex of each year. If you add the two together and subtract the risk-free rate (the rate of ten-year US treasury notes), you get a series with plenty of peaks and dips, but one that hasn’t significantly declined or increased this century. Let’s play with this notion a little. The first few years, g is at one level, the next few it’s at another level, and at the end it’s at quite a low level. I have no business relationship with any company whose stock is mentioned in this article. Because the implied discount rate varies a great deal from year to year, the difference between sectors is far, far lower than the difference between years. Catherine D Wood 's reported Net Worth at least $106,000 as of September 21, 2020. I relied primarily on FactSet data, but checked Compustat data as well.). No, pricing a public company is unlike pricing anything else. Surprisingly, however, free cash flow was an extremely poor predictor of shareholder payout. I decided to take a look. View all Motley Fool Services ... What's the Stock Worth Now? (If you’re a Portfolio123 member and want to know how I calculated the discount rate, I created a universe of all stocks that have reported annually for fourteen years or more, have a market cap of $30 million or more, and sell at a per share price of $1 or more. The way to take care of this conundrum is to define the net increase in a collectible’s value as its dividend. And, of course, a young company will not have many annual statements in its history while a mature company will have a lot. Aswath Damodaran www.damodaran.com Aswath Damodaran. I then took the geometric mean of all those median growth numbers and came up with a relatively smooth curve. © 2020 Forbes Media LLC. We shouldn’t look only at how many annual statements a company has filed to determine this; instead we should also use a company’s characteristics. The sales growth diminishes linearly from year to year down to a final value of 8.3%, which is a somewhat arbitrary number I use for high-growth companies. I came up with a rather complicated formula and a ranking system to classify companies as mature (top 50%), infant (bottom 25%), or in-between. The fact that mature companies grow at a steady rate gives us a way to calculate the discount rate without depending on guesses as to the return of an equally risky investment. The founder of a startup will begin market validation by problem interview, solution interview, and building a minimum viable product (MVP), i.e. This is what you can expect as a company grows from year one to year nineteen: As you can see, a typical company will start with a sales growth of around 19% per year, hold steady at that rate for about five years, then slowly fall to around 6% after fifteen years or so, after which growth will be relatively steady again. At the very bottom are the companies with the largest negative value: Uber (UBER), Peloton (PTON), and Zoom Video (ZM). The essential point is that security analysis does not seek to determine exactly what is the intrinsic value of a given security. Aswath Damodaran's stories. Here’s my rough calculation of its intrinsic value. I also thought that one could specify discount rates for specific sectors. It is a kind of guessing game; it’s irrelevant for extremely high-growth and low-payout companies; and at best it can only give us a very rough idea of what a company is worth. How do we assign a value to a collectible, an artwork, or a bar of gold? I wrote this article myself, and it expresses my own opinions. He has posted a full semester’s worth of both classes on YouTube. My results are not better than Damodaran’s or Simply Wall St’s or Warren Buffet’s. To some folks that may seem unrealistic, but to the true believers it’s an understatement of the magnitude of Tesla’s future success. And all three of these sectors face enormous uncertainties in the years ahead as our health-care system and energy use change. I divided my universe of mature companies into two groups: those with a five-year beta greater than one, and those with a five-year beta less than one. So the present value of future cash flows may not be the right way to value a company’s stock. Cash generated by profits, or free cash flow, can pay down debt, generate growth, be returned to shareholders, increase executive compensation, be invested outside the company, or just sit there. They’ve avoided actually looking at the evidence and asking the hard questions that result. Its projected shareholder payout is $453 million. The results were even more extreme: low-beta stocks deserved a discount rate almost 2% higher than high-beta stocks. Its overall average is 5.84% (again cap-weighted), but its average between 1999 and 2006 is 8.50% while its average between 2012 and today is only 3.37%. Let’s look at shareholder yield first. The conventional way to handle this is to use a two- or three-stage growth model. Valuation is a Science and an Art. Ms. Wood holds over 2,400 shares of NexPoint Residential Trust stock valued over $105,504 and has sold NXRT stock worth over $0 in recent years. But it suits my personal style. But what if we use EPS or EBITDA growth for g? Aswath Damodaran I am a Professor of Finance at the Stern School of Business at NYU. In addition, some people think R&D expenses should be capitalized, and others don’t, which will seriously affect earnings and EBITDA figures. So what? I compared shareholder payout in one year to the previous year’s possible indicators of shareholder payout. This makes some intuitive sense. Instead, the purpose of this article is to. Aswath Damodaran (born 23 September 1957), is a Professor of Finance at the Stern School of Business at New York University (Kerschner Family Chair in Finance Education), where he teaches corporate finance and equity valuation.. They can survive indefinitely or go broke tomorrow. So our approximation of intrinsic value is a pretty holistic measure. But on the whole, few investors actually practice it, despite paying lip service to it. For adolescent companies, a two-stage valuation will work, but is somewhat complicated. I’ve created a Google sheet with all my formulas; they're in Portfolio123's language, but it's pretty transparent, and there's a glossary for troublesome terms. ... Pfizer and BioNTech expect to produce up to 50 million vaccine doses in 2020, and up to 1.3 billion doses in 2021. I’m not claiming that it’s better than what others (e.g. It decreases from there to a final value of 2.18%, which is based on a formula that takes into account projected shareholder payout as well as the growth of shareholder payout over the last five years. That is because intrinsic value is concerned with the far distant future. I wrote this article myself, and it expresses my own opinions. I then divided this by the total market cap of all these companies at the beginning of the fiscal year I was measuring. They are indispensable figures and should never be ignored. If we were to do so, then there would be no justification—besides the market’s extremely opaque estimate—for some companies to be valued at hundreds of billions of dollars while others are valued at only a couple of million. I calculate forward shareholder yield by taking the shareholder payout as defined above and dividing it by the market cap at the beginning of the payout period. If we use 9.43% as our discount rate, a mature company with 0% expected revenue growth will be worth about 11 times its expected shareholder payout while a mature company with 8% expected revenue growth will be worth about 70 times its expected shareholder payout. If g were constant for all periods (it’s not), a simple mathematical reduction would result in the following formula: where PV is present value, d1 is next year’s dividend, r is the discount rate, and g is the steady growth rate. As a long-time Apple user and investor, I must confess that I was bothered by the way in which the film played fast and loose with the facts, but I also understand that this is a [...]. So I would conclude that NVR is fairly priced or slightly underpriced. Underpriced stocks haven’t outperformed basic benchmarks. Instead they’re based on how accounting and finance should, ideally, work. After taking Professor Damodaran's Advanced Valuation course in 2019, I am now enrolled in a graduate diploma course in Mining Law, Finance and Sustainability where the course argues that ESG investing will pay off for both companies and investors. When a company chooses one of the other options, why should that affect its return to shareholders—and therefore its intrinsic value? Ideally, the discount rate one applies depends on a measure of the security’s risk. But a public company is not a collectible or an artwork or a bar of gold. We could, as most do, just trust the market to do it. Margin is the percentage of revenue that remains after various costs have been deducted. It needs only to establish either that the value is adequate—e.g., to protect a bond or to justify a stock purchase—or else that the value is considerably higher or considerably lower than the market price.”. Yes, risk and reward are correlated up to a certain point, but beyond that point, the higher the risk, the lower the reward. There are plenty of companies that have reinvented themselves and gone from old age to infancy in terms of their growth rates. Because future prices, however, must always be discounted to arrive at present value, the value of Tesla a hundred years from now will make very little difference to today’s price, while its value two or three years from now matters a lot. The stunning rise and drastic drop in Valeant's stock price is a reminder that growth built on acquisitions almost always hits a wall. Companies do go through stages: a stage of extremely high but steady growth, a stage of declining growth, and a stage of low but steady growth. (The actual formula is at the end of the article.) Then I did this again and again, going back year by year to 2003, which is when I exhausted my coverage. It doesn’t take into account a lot of things—there’s no asset turnover, no consideration of debt, no return on equity or assets or capital, no free cash flow or capital expenditures, no enterprise value. Then I took the median growth of those companies over each of the last nineteen years. Some companies have high revenue growth but poor prospects of actually converting that revenue into shareholder payout. I am a professor at the Stern School of Business at New York University, where I teach corporate finance and valuation to MBAs, executives and practitioners. Is … The newest superstar investor has leveraged a zealous belief in innovation into a $29 billion-in-assets firm and a $250 million net worth. It seems reserved for nerds and members of the Warren Buffett cult. Ideally, a portion of revenue becomes free cash flow, which is then returned to the shareholder. This is called the equity risk premium, and it has an average of 5.99% overall. If we assign an 11% discount rate to the tech company and a 7% discount rate to the utility, we come up with an intrinsic value of $10 billion for the utility and $4.3 billion for the tech company. But practically everything else about a company should be taken into account when estimating these numbers. The growth/value dichotomy that so many people talk about is a false one when it comes to intrinsic value. By this formula, Apple’s (AAPL) projected sales growth is 14%, Microsoft’s (MSFT) is 13%, Amazon’s (AMZN) is 25%, Google’s (GOOGL) is 15%, Facebook’s (FB) is 19%, and WalMart’s (WMT) is 3%. But maybe you can play around with it some and come up with something better.