Top Valuation Guru: Stock Market Warning

The so-called “Dean of Valuation,” Aswath Damodaran, recently spoke about what’s going on in the current economy, including inflation causing “false hope,” and what valuation principles all investors should know.

Why should you listen to him?

Aswath Damodaran teaches corporate finance and equity valuation at New York University, where he serves as the chair of Finance Education.

He has authored several widely used academic and practitioner texts on the following topics:

  • Valuation
  • Corporate finance
  • Investment management

Damodaran is most widely quoted on the subject of valuation and has been published in a number of financial journals, including:

  • The Journal of Financial and Quantitative Analysis
  • The Journal of Finance
  • The Journal of Financial Economics
  • Review of Financial Studies

The False Hope of Easing Inflation

In a recent interview, Damodaran shared his thoughts on current global inflation.

He said it’s not the high levels of inflation that are the problem, but rather it is that the inflation levels are higher than any experts expected.

Damodaran called this kind of unexpected inflation damaging to both businesses and investors, especially because after a decade of low and stable inflation, we’ve become spoiled, with many young investors, business owners, and consumers never experiencing this kind of inflation until now.

Damodaran said as devastating as recessions are, sometimes, the only way to bring combat inflation that’s raging out of control is by bringing the economy to a crashing hard landing.

Periods of inflation are never stable, and the inflation ebbs and flows, which Damodaran said can sometimes lead to false hope, where people may incorrectly assume that inflation is coming back under control only for it to flare up again. This includes the Central Bank and the Federal Reserve.

Damodaran said his biggest concern right now is that Fed Chair Jerome Powell will take this false hope of easing inflation and give up the Fed’s inflation-fighting efforts after a few good months, which in the long-term, when inflation returns with a vengeance, will make things much worse, creating even more pain for people at the bottom of the spectrum who are working for their wages — the ones who are most at-risk during times of inflation.

Damodaran’s Key Principles of Valuation

Given the current state of the economy, Damodaran said it’s all about cash flows, growth, and risk — no matter the asset class.

But keeping your eyes on cash flows, growth, and risk is particularly important for people investing in traditional asset classes, like businesses, equity, and bonds.

Separating Price from Value

In terms of assets being overvalued or undervalued, it’s important to recognize a simple truth about the market: you control the value part. Of course, the price is not in your control, and there’s nothing you can do to force the market to do what you want it to do. That’s why it’s important to separate price from value.

Damodaran suggests that investors should start doing research on catalysts. While there’s no magic formula that will cause price-adjusted value, catalysts can cause prices to adjust the value.

Some examples of catalysts include new management teams, companies collapsing and merging, and other macro events.

Damodaran said investors spend a lot of time on the value part of the process and not enough time on the pricing part. H

e said more focus should be directed on the people who drive prices — the people who are often using charts and technical analyses that a lot of investors choose to ignore.

Damodaran has been paying close attention to the traders driving up AMC and GameStop, not because he gets enjoyment from it, but because what they do affects his portfolio because they’re the ones setting the prices, meaning he’s at their mercy when he buys something that’s undervalued. When they push the price up, it allows him (and other investors) to reap the benefits.

Time As Your Ally

Time is the ultimate ally to investors, according to Damodaran. But, it’s important for investors to recognize that sometimes they may run out of time before the adjustment takes place, citing an old Keynesian saying that the “market can stay irrational longer than you can stay solvent.”

It’s important for investors to remember that while time is your ally, your time horizon is not always in your control. This principle actually gives individual investors an advantage over portfolio managers because, for portfolio managers, their time horizon is only as long as their shortest-term client.

Patience is a Virtue

According to Damodaran, patience is the number one value that all value investors must have, especially during times of economic downturn and volatility. He said that investors who are naturally impatient will fail because they simply don’t have the right temperament to be a value investor.

He said that to be a successful investor, the person you need to understand the most is yourself — not Warren Buffett nor Peter Lynch; when you can understand what makes you comfortable and uncomfortable.

He recommends an investment journal where investors can write every day about how certain market activity made them feel. This will help you gain a full understanding of what makes you uncomfortable, and then you can work to reduce it so that the discomfort does not rule your decisions, and you can stay calm, cool, relaxed, and patient with the market to experience the most success rather than letting the discomfort get in the way of your success.

When you don’t take this approach and let the discomfort reign, he said you’ll start selling things too early because your anxiety, discomfort, and impatience won’t be able to handle it any longer. Don’t push away your discomfort, deny it, or ignore it. Instead, accept it, sit with it, and let it teach you how to be a better investor.

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