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Aswath Damodaran: "The Value of Stories in Business" | Talks at Google


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At 1:20:40, there is particularly interesting discussion of "faith" in valuation. I've been thinking about this for a while as well.

 

In value investing, figuring out the intrinsic value is the key. You benefit from the mismatch between the price and the intrinsic value. Yet, there is no scientific way to validate any method of computing intrinsic value. After all, the concept of intrinsic value itself is intrinsically subjective and never manifests itself in reality (in contrast to an objective phenomenon such as gravity or even socially constructed reality such as stock price). So you can never measure it to confirm / disapprove your method.

 

So what do we do? We have to have faith in our process... Otherwise the whole idea of value investing falls apart.

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Things that are worth doing are always murky. Once a problem is solved or verified the value get arbitraged away. IV is based on the result all  possible outcomes.  That is why there are many layers of heuristics after the initial IV is done. Position sizing, Margins of Safety, handicapping and most importantly the expected businesses characters in the years follow the investment. (to know when to sell)

 

The principles are easy to understand but hard to apply in real life. You are always taking on risk when you make an investment the most important question is, are you correctly compensated for taking it or Is it mispriced?

 

Damodaran and most people spend too much on coming up with a believable number to show people. When in reality he should spend almost all of his time on the risk or the characteristics of the cash flow. Which is beyond the realms of numbers.

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Coming somewhat from a scientific background, this is a relevant question for me too.

To deal with uncertainty can be fun and rewarding.

Yes, stories, hunches, intuitions play roles.

However, thinking of fields where art and science are combined, perhaps a way to bring uncertainty down to a level contained within a margin of safety is to use a thought process based primarily on the deliberate application of a framework guided by rational, analytical and rules-based criteria. To check your assumptions.

 

In contentious legal issues, each case "story" is different but case law comes up with frameworks, rules and principles.

For controversial accounting reporting requirements, accounting boards use guidelines and other criteria.

In complex medical presentations, the "story" is different but there are clinical and radiological criteria, clinical scoring systems as well as diagnostic and treatment algorithms.

 

My point is simply that if you start with a decision tree based on "hard evidence" (more objective and verifiable), you may be able to incorporate the subjective aspects into a relevant range of intrinsic values.

If you take an insurance company like Fairfax, based on the "numbers", I would submit that most would come to a relatively narrow range of intrinsic value. On this board, for instance, there are often comments on the IV based on reported balance sheet values. However, if you add the "story" part, you may adjust (up or down) the estimated IV and the associated margin of safety.

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5 Steps to Valuation

 

1. Tell a story about a company

2. Make sure the story is not a fairytale (is it possible, plausible & probable?)

3. Convert the story into numbers & a valuation

4. Don’t tell people your story if they’re just like you

5. Tell your story to people who are your opposite.

 

Be a disciplined Storyteller (write fact & minimize fiction.)

 

Bezos has told a consistent story.

Markets don’t trust inconsistent stories.

 

The analysis of the story seems to be the link between art & science.

 

As an investor, you need to be a good story interpreter.

(I know there was at least the idea of a whale in Moby Dick.)

 

How can I trust which parts of the story are mine?

 

---

 

Are you a storyteller or a numbers cruncher?

 

Some number cruncher delusions are precision, objectivity & control.

How can a number cruncher learn to trust their imagination?

 

Google is a good place to start your research but you have to become a true journalist to sleuth the story (customers, employees & vendors.)

 

 

Don’t price things, value them.

 

I enjoy driving my cheap assed Colorado; I’d definitely drive a Ferrari every friggin’ day for the fun of it (what’s the point of having one otherwise?)

 

I love the story about Musk & his Mclaren (not told in Damodaran's vidi)

 

Here's him getting the F1

 

https://youtu.be/bANJqh3SL6o

 

 

I disagree with his opinion regarding some goodwill (BRK)

 

 

Damodaran doesn’t like telling horror stories but enjoys the experience you get from telling them.

 

Favorite book = Moneyball

Under-appreciated books = non-business books

(philosophy, fantasy, etc., do serve a purpose for investors & those who don't enjoy discussing them here in an amicable way, have not achieved any form of consciousness...)

 

 

He picked Vale too!?! (I f’ed up & bought a tiny bit when working in Brasil & have been too embarrassed to put it in my signature) I also bought the story Eike Batista told about OGX & wanted to see a Brasilian E company transition to a P co to compete with Petrobras) but the story failed due to incompetence.

 

Both were small & I keep them as warning signs (just ordered a 1 share cert of OGXPY & will frame it with a photo of Eike looking his douchiest.)

 

 

Is Prem Watsa telling a story about India that’s possible, plausible & probable?

 

 

When all else fails, blame everything on China…

 

 

Note to self: Do this with Express Scripts (not the blaming China thing, but the storytelling checks...)

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  • 3 months later...

Interesting talk.

 

The risk of trying to make person both number cruncher and storyteller is that instead of intended checks-and-balances you might get a reinforcement. I.e. instead of story checking the numbers or numbers checking the story, you get double confirmation bias: "not only numbers(story) but also story(numbers) support my investment thesis!!!"

 

Damodaran makes both sides look easy. Neither side seems easy to me. Yeah, sure, it's easy to create fantasy stories. But it's not so easy to create what he calls "probable" stories and distinguish them from "(im)possible". Yeah, sure, it's easy to write up a bunch of (ir)relevant numbers. But it's harder to create a numerical model that is indepth, both conservative and realistic, and made from numbers that matter. And then you also have to connect the two.

 

I see only few people who do what Damodaran suggested in his talk. And I don't think this is because people think his approach is bad. I think it's because it's not that easy.

 

Another issue is that ultimately he does (his own version of a bit more complicated) DCF. And DCF has its own set of issues that may not be connected with business and story (large part of value ends up being terminal value, which is difficult to predict; discount rate affects DCF a lot and what Damodaran uses - weighted cost of capital - is IMO controversial; etc.).

 

Anyway, Damodaran's approach is pretty interesting and might be a good set of tools for some investors.

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Coming somewhat from a scientific background, this is a relevant question for me too.

To deal with uncertainty can be fun and rewarding.

Yes, stories, hunches, intuitions play roles.

However, thinking of fields where art and science are combined, perhaps a way to bring uncertainty down to a level contained within a margin of safety is to use a thought process based primarily on the deliberate application of a framework guided by rational, analytical and rules-based criteria. To check your assumptions.

 

In contentious legal issues, each case "story" is different but case law comes up with frameworks, rules and principles.

For controversial accounting reporting requirements, accounting boards use guidelines and other criteria.

In complex medical presentations, the "story" is different but there are clinical and radiological criteria, clinical scoring systems as well as diagnostic and treatment algorithms.

 

My point is simply that if you start with a decision tree based on "hard evidence" (more objective and verifiable), you may be able to incorporate the subjective aspects into a relevant range of intrinsic values.

If you take an insurance company like Fairfax, based on the "numbers", I would submit that most would come to a relatively narrow range of intrinsic value. On this board, for instance, there are often comments on the IV based on reported balance sheet values. However, if you add the "story" part, you may adjust (up or down) the estimated IV and the associated margin of safety.

 

Excellent point Cigarbutt. Very much like the analogy of combining science (calculation of metrics) and art (the story) as relates to investing.

 

Question I have is, in a market downturn (i.e.: 2008-2009) does it matter? Everything seems correlated and the formulas break down. During a recession despite having a solid calculation of IV and story, the stock tanks - "baby gets thrown out with the bath water" phenomenon. During boom times, so much seems to do well, regardless of IV. Is Mr. Market too well correlated for us to not only identify mispriced assets but for the thesis to play out ? Despite all the science behind Value Investing is Passive Investing "winning" ?

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Thought provoking.

What comes to mind:

 

-Thinking like a private investor may help.

-What Mr. Charlie Munger has said:

 

http://www.valueinvestingworld.com/2013/11/charlie-munger-on-his-experience-in.html

 

https://www.cnbc.com/2017/02/15/stock-pickers-beware-charlie-munger-thinks-youre-in-big-trouble.html

 

To be a contrarian value investor is nice challenge. You have to be different AND right.

 

Passive investing is certainly "winning" now.

 

 

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