What is common between Aswath Damodaran and Forrest Gump, one a widely published professor of finance at the Stern School of Business at New York University and the other a naive, unintelligent fictional hero? Well, both got lucky with investments in shares of Apple Inc. Damodaran bought the shares for around $5 each in 1997, which he describes as an emotional investment, selling them eventually for $600 last year.
Damodaran is known for his books on valuation, including Damodaran on Valuation and the recent The Little Book of Valuation. In addition he has co-edited a book on investment management with Peter Bernstein and has written books on investment philosophies and risk management. A popular teacher, he was voted as the most popular teacher in a Businessweek survey of MBA students in 2011, in addition to winning Stern’s Excellence in Teaching award seven times.
Damodaran is in India for Stern’s first India Business Forum and shared his thoughts on investing in India, factors Indian companies should look out for while making acquisitions, following a value investment strategy in a world of momentum investing and high frequency trading. Edited excerpts from an interview:
Tell us about your Apple investment. Was there an element of luck or did your investment principles help?
Well, there was a huge element of luck. I invested emotionally and for all the wrong reasons. I viewed it as my last blow against the dark empire, which at the time was Microsoft. Essentially, I was saying, this (Apple) is a better system. And having used Apple products since the early days, I thought it’s the least I could do in supporting the company when people were saying it was going down. Often, when you make investments, the ones that pay off have very little to do with perfect timing and great analysis. A lot of it has to do with luck and being at the right place at the right time.
So where does sound investment principles come in?
What I have learnt is that most of the experts who claim to know what the value of the stock is have no idea what it is. So I don’t read equity research reports and I don’t listen to what analysts tell me about a stock. I feel confident enough in my assessment of value and I can take a stand on it.
What about people who aren’t equipped to do that?
I feel bad for saying this, but for most investors who have other jobs and have just short 15-20 minute windows to think about investments, it’s best for them to find the lowest cost passive investment fund. Plus, they should care very little about past returns.
What is your opinion of India as an investing opportunity?
Increasingly, countries matter less and less in the investment process. What we have are global multinationals that happen to be incorporated in one place or another. The nationalistic pride that we get when an Indian company does great things is fine. But I think at some stage of the process we need to recognize that incorporation is an accident of history. These companies are all competing in a global market place. So I’d invest in a good Indian company, just as I would in a good Chinese company. What has changed in the past decade is that when you look for investment opportunities, you have more choice among companies incorporated in emerging economies.
Has the increase of high-frequency trading, large exchange-traded fund flows and momentum style investing made it more difficult to implement a value investing strategy?
On the contrary, it makes it easier. Momentum is your best friend. If you are value investing, you need the price to be different from value. You want extended periods when price departs from value either on the way up or way down. Of course, it will only work if you have the stomach to ride out the wave brought about by momentum investors. You may at a price thinking it’s value, but momentum may push it far lower. It’s easy to be a value investor in abstract, but difficult to be a value investor in practice.
Given that maximizing shareholder value is the main objective of companies, how should they look at short-term movements in prices?
Most companies who claim to maximize stockholder wealth are maximizing stock prices. And sometimes you can do things to maximize price, which will eventually harm the company’s value. At the same time, ignoring prices is a dangerous thing to do—even if you don’t believe that the pricing process is efficient. For instance, companies who announce acquisitions and see their share prices fall dismiss it as a short-term reaction from investors. But the initial drop in share prices post an acquisition announcement is the best predictor of whether an acquisition succeeds or not.
When prices move in a direction that’s not convenient for managers, their argument is ‘we’re long-term, they’re short-term and that’s the problem’. I’ll say the average stock market investor is far more long-term than the average manager, who is thinking about his compensation.
Talking of acquisitions, how should Indian companies approach them?
I think there are ways of having an acquisition strategy that focus on what will increase your odds of succeeding. When you look at history, acquisitions of small companies (relative to you) work better than those of large companies; acquisitions for cost savings are more likely to work compared to those which go after growth synergies, acquisitions of private companies work better than public companies. So one can create an acquisition strategy and have a focus. The challenge is to stick to this strategy, rather than get more and more ambitious.
You have said that asking an investment banker whether a deal makes sense is analogous to asking a plastic surgeon whether there is anything wrong with your face. What role should companies let investment bankers play?
First, companies shouldn’t be getting their advice from banks. What’s the advice for? Managers are being paid to make these decisions in a company. The obligation of doing homework on a deal rests with the company management. I don’t think it takes any incredible skills to value a company. It’s just basic fundamentals. The only reason companies ask banks for advice is so that they can pass the buck if the deal fails—they can say ‘Well, Goldman Sachs told me to do the deal.’
Investment banks must be used the right way, i.e. to get the deal done. Don’t ask them whether the deal should be done. That’s a dumb question to ask.
What is the lesson from the Hewlett-Packard-Autonomy fiasco (HP, which bought Autonomy last year, has accused the company of misrepresenting its performance ahead of the acquisition)?
That companies must have strong corporate governance. To me, corporate governance has become a bit of a joke, because it’s become all about appearance. For example, the HP board actually met the Sarbanes-Oxley requirements and seemingly had an independent board. Good corporate governance cannot be legislated. It has to come from below—from shareholders who look after their own interests. Good corporate governance brings in a check on the top management—a board that actually asks it ‘Why are you doing what you are doing?’
India is moving to International Financial Reporting Standards (IFRS) accounting standards. Will that help investors?
They’re making financial statements into data dumps. They’re looking at every conceivable bit of data that someone has use for. It’s done with the best of intentions. But one must remember is that if someone wants to commit fraud he will. The most stringent of rules won’t stop the person, but it will make life difficult in terms of financial reporting for everyone else. And for investors, it will be a nightmare to get through them—to decide what matters and what doesn’t.
So IFRS will make financial statements more full, but not necessarily more useful.