Aswath Damodaran on luck, humility and arrogant money

When Aswath Damodaran so graciously and promptly agreed to be interviewed, I kept telling myself that I should not screw up. Well, it began with the very first question.

This is what is so awe-inspiring about him. Every single encounter - via a video or a write-up or an interview, one walks away learning something or getting a fresh perspective. There is no separating the teacher from the person. Such talent is priceless.

This is part of a series where I attempt to understand the behavioural traits and mindset of money managers and investors. At the end of this (slightly edited) transcript, I have listed the 20 individuals interviewed for this series.

ASWATH DAMODARAN teaches corporate finance and valuation at the Stern School of Business at New York University.

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As a professor, you are as objective as possible, but as an investor…

Let me pause you right there. I am not objective, but I am open about my biases. Anybody who ever claims to objective is right off the top lying. None of us as human beings are capable of being objective. All we can do is be open about our biases. I am open about my biases.

Okay. Then let’s start there. Can you tell me about a bias you have successfully overcome and one that you are combating with right now?

I don’t think you ever fully overcome a bias because it is in-built. It is in your DNA. All you can do is be aware of it.

I will give you an example.

I love Apple as a company. I have loved it since 1981 when I first bought it. And I struggle with that love every time I value that company. I can’t make it go away. But one of the things I can do is step back when I make a choice and ask myself if I made the choice because I like Apple as a company or made the choice based on something more solid, based on numbers.

It is an ongoing process. You never get rid of it because it constantly recreates itself.

You are instinctively a left brainer, but you merge the story with the numbers. And you do it pretty successfully. But has that ever resulted in you missing a good story because you were way too focused on the numbers?

I’m sure. And the reverse has also been the case, where I looked at the story and liked it so much and not looked at the numbers hard enough.

It is not a question of missed a company, rather, missed a company at a point in time because I was too focused on the numbers. That is really the way to describe it.

Valuing companies is an ongoing exercise. I have been valuing Uber every year since 2013. I have been valuing Tesla every year since 2013. Which means that I can point to a valuation and say that in 2013, when I looked at Tesla, here are the things I missed by looking at the numbers. I thought of it as a luxury automobile company but what I was missing was the transition to electric cars that was revolutionizing. It was creating this entry point. I wish I had seen it then because I might have bought more shares of Tesla at that time. But by 2019, I had moved onto a different set of issues where I was focusing on Tesla as one of the major electric car companies.

So you make mistakes about a company at a point in time, rather than a company across time.

Can you share an investing principle that you fervently believe in but is not a popular stance?

What is at the core of disagreement is a different philosophy.

For instance, when I value Zomato and say that it is worth Rs 40 or 50 per share, I am not saying that it is a bad company or bad investment based on the cash flows and what I can see.

There’s a difference between an investor and a trader. In investing, you try to value a company (with error) and you try to make judgements based on that value. In trading, you play a much simpler and perhaps more honest game. You buy low and sell high. You build on mood and momentum. So, when I get disagreements from people, it is more because they believe in trading rather than investing. And that’s perfectly okay. I am not going to claim that they are wrong and I am right, because I have no way of knowing.

Each brings a very different set of tools to the game. Much of the disagreement I get and the pushback I face is from people who come from a different perspective.

I respect that and I back away. You make your decisions based on your philosophy. And I will drive my decisions based on mine.

How do you ensure that you are not locked in the echo chamber of your mind?

You are never sure. That’s why this is a process. I have a 5-step framework to value companies.

I start with a story because I want to start with my weak side. My strength is being a number cruncher, so I build on my weak side first. I convert the numbers. I come up with a value. Then I keep the feedback loop open.

Show the valuation to people who think least like you. We tend to hang out with people who think like us. They go to the same schools. They read the same books. They use the same models. Unsurprisingly, we tend to agree with each other all the time.

I am lucky to have readers who come from very different backgrounds. They may not be finance people. They may not even be in business. So I get feedback from people who do not think like me. And I have to be careful not to shut them out but to listen to the things they say. Not to say “Look, I know valuation and you don’t”, because that is a very elitist view.

The only way to keep yourself honest is to hang out with people who don’t think like you because they force you to re-examine what you take for granted.

If someone categorizes you as a value or growth investor, do you find these silos extremely restrictive? Do they paint you into a corner?

I would not be quick to jump into those silos because I am not sure what’s in them.

I think people creating these silos are not even sure of what they are. If someone calls themselves a value investor, ask them what it means to be a value investor.

Most value investors have never ever valued a company in their lives. Ever. I am talking about 90% of the people who show up at Omaha. They have never actually valued a company. Their idea is buying stocks with low PE ratios and high dividends. That is not value investing. That is pricing.

Often people are not even aware of what they doing because they are so quick to label themselves. “I listen to Warren Buffett. I have read three books on Warren Buffett. Therefore, I am a value investor.” I am not sure that’s a good definition of value investing.

My idea of value investing is very different from the silos you see on value and growth.

My definition of value investing is that I value something, and if I get a price lower than the value, I am going to buy that stock. I don’t care if it is a high-growth company or a mature company. The only way I describe myself as an investor is that I am consistent with my own philosophy on what value is. And I invest based on that philosophy.

You are welcome to disagree with it. It is not my job to talk you into using my philosophy. Because what business is it of mine?

I value companies for one person, and one person alone. That’s me. I do not value companies for others. I am not an equity research analyst. I am not a portfolio manager. I am not trying to sell you an idea.

Investors have to take ownership of their decisions. You cannot buy a stock because you heard Jim Cramer promote it on CNBC. Or because you read about it on Morningstar. You have to buy a stock because you believe that it is a company that is right for you. And that requires investing time and resources and coming up with a philosophy for investing that you are comfortable with.

Do you find the monickers of “valuation guru” or “dean of valuation” amusing? How do you view them?

I find them distracting. In the sense that they make it seem that I know more than I do.

Valuation is simple. It is one equation. There is nothing advanced or sophisticated about valuation. It is pragmatic. To be a dean or a guru in something that is one equation sounds to me like not much to aspire to.

Also, people will listen to or read about a valuation that I have done and assume that somehow I know more about value than they do, all because of this monicker. In fact, almost every valuation that I do, in addition to telling you what I think the value of a company is, I put out a completely open spreadsheet with no macros or special features, and state that this is my story and my value for the company. Make it yours. What that effectively means is that you can disagree with me. You can disagree with my story on growth. On profitability. On reinvestment. On risk.

Rather than bitching and moaning about how much you dislike my story and my value, which is driving my decision, change them, come up with your value, and make your decision. There is nothing wrong with buyers and sellers co-existing at the same time.

Between the spreadsheets and the story, does gut feel come into play?

I always mistrust my gut. Gut feeling is just your emotional side acting up. And we know what emotions do to investing.

What we call gut feel is essentially a bias playing up. So I am wary of it. How can I have a gut feel about Birkenstock? What gut feeling can I have about a shoe company in Germany that has been around for 250 years that is going to change the value of the company? I do not trust my gut to move around the value of a few million or billion dollars just because my gut feels more comfortable with a higher or lower value.

Investing is a game of probabilities. Do you believe that there is anything called luck in this entire game?

It is the only thing that matters because 90% of what happens in the world is outside your control. The probabilities cover the 10% that is within your control.

This is why you spread your bets. I have never understood people who concentrate their investments in four or five companies. You can have the probabilities in your favour but luck is such a dominant paradigm in this business that you can be right and go bankrupt being right.

Hubris is the biggest enemy of good investing. Hubris is when you say, “I have worked out the probabilities. They are in my favour. Therefore, I am going to load up on these few companies because I feel I am going to be right.”

Luck is the dominant paradigm. You cannot make it go away, but you can reduce your exposure to it by spreading your bets and being humble. All you have done is altered the odds of success from 50% to 52%. Not 50% to 95%.

You can do everything right, but you cannot control what the world will deliver as surprises.

“You can be right and go bankrupt being right.” What do you mean?

I often hear investors use the word conviction. The word conviction terrifies me. It suggests that I feel so sure about this investment that I am going to take most or all of my money and buy this stock. The stock goes down. But because you have this conviction, you double down. You double down again. Before you know it, you have mortgaged your house and sold the rest of what you own. And all your money is on that stock. Then the call comes because essentially you have borrowed money. You get bankrupt. You are in debtor’s prison. Ten years later you might end up being right. The stock you picked might have bounced back but you were not around to see it come back because you put yourself at risk.

Don’t risk your entire investment portfolio by doubling down and tripling down on bets when they go against you. Sometimes, it is good to step back and say, I have made my bet. I feel good enough about it to let it ride. But I am not going to double down or triple down on it because that is a recipe for disaster.

How successful have you been in keeping your ego in check when it comes to investments?

I would love to say that I kept it in check, but I cannot.

Sometimes I have to stop and say, “Are you getting a little ahead of yourself? Are you too full of yourself?” This is why you must keep the feedback loop open.

If I hang out with CFAs, they will pat me on the back and say this is amazing. We’ve heard the same sermon. We’re singing the same hymn. That is why it is critical to talk to people who disagree with you. I talk to bankers. I talk to VCs. I talk to founders. I talk to people in very different spheres of business. That helps. Sometimes they ask me questions about the fundamentals of finance, and it is healthy for me to have to defend what cost of capital is. Rather than have to talk about the mechanics of how to compute cost of capital.

You once said that you respect the market, but don’t revere it. What did you really mean by that?

When you revere the market, you believe that the market is right. You believe in an efficient market, which is a core philosophy in itself. Then you stop trying so hard to pick stocks. You pick an index fund and move on with the rest of your life. For 90% of the people, that might be the healthiest choice. A doctor, dentist, an engineer – you have a life to live and a job to do. Do your job. Take your savings, invest in index funds, and move on.

Revering markets means that the market is always right. It is usually the people who are wrong, not the market.

I am not at that stage. I respect the market. When the market moves, I always stop and ask, what did I miss? If the company moves in an unexpected way, what did I miss? And I look for things that I have missed. What is the market seeing that I am not seeing? And perhaps I will come to the conclusion that the market is wrong but that should be the final conclusion. Respecting markets means that you never start with the presumption that you are right and the market is wrong.

That is why I hate the use the word bubble. The moment you use the word bubble, you are already telling me that the market is full of irrational and shallow people are you are somewhat deeper and more rational than them. That is putting yourself on a pedestal which you really don’t deserve.

What is it that you respect in people, be it personal, students, managers, promoters?

Humility.

I do an entire session on smart money. I have been looking for smart money for 40 years. I still have not found it. I have been told that hedge funds or venture capital is smart money. Everytime I look deeper, it doesn’t look that smart.

I would prefer the categorization of humble money and arrogant money. I would not put a dollar of my savings with the arrogant money.

I will give you an example of arrogant money. Masayoshi Son. At one time he was viewed as a legendary investor. He is Japanese. When you are Japanese, you cannot admit to being arrogant. You have to play the humility act. He is a humbragger; one who pretends to be humble when bragging. He has a 300-year plan. Who makes a 300-year plan? Only people who have delusions of being God make 300-year plans.

When WeWork fell apart, my first reaction was how can you trust two arrogant people in a room? Adam Neumann, CEO of WeWork, and Masayoshi Son, founder and CEO of Softbank? What comes out of that room? A recipe for disaster.

Humility is the starting point. Then I look for good sense – do you know how to build a business? Converting a great idea into a business requires you to put in a lot of hard work. You need people around to delegate. If you try to run everything, if you are a control freak, you will get into trouble.

What repulses you in people?

Arrogance. And the notion that you are on a moral high ground.

I know the answer. I am right.

Anytime you believe that you are in the right and the other side is wrong, and you combine that with arrogance, you are off to the races then.

As a professor, what is something about your job that you find exhilarating and what do you find most challenging?

I am not an academic. I am not a researcher. I am not a professor. I am a teacher. Teaching is what makes me tick. Teaching is my passion. It is not a job. If I was not teaching corporate finance, I would have been teaching another subject.

I hate it when people call me Dr Damodaran. Let’s reserve that title for those who have medical degrees. You don’t want me around when you get a heart attack. I have never understood that fixation with having Dr as a prefix just because you have a PhD.

What gives you sleepless nights?

My family. My children. Someone’s health in my family.

Not stocks. Not investing. Not over a valuation I have done. Not over a company that I am valuing.

I tell people that they need to pass the sleep test. If they lie awake at night, wondering what your portfolio is doing, you have failed the test. It is an indicator that there are things in your portfolio that don’t belong there.

Reserve your sleepless nights for things that truly matter. It should not be business or investing or your portfolio.

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6. Devina Mehra
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