Then we’ll take that as a percentage of these companies’ total market cap (shareholder yield). 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. And that’s a comparative process. A young company may not yet have figured out how to transform revenue into earnings and cash flow; a mature company will have solid and stable earnings and cash flow. Please note that I did not backtest my system before coming up with it to see whether it would actually make a profit. Its projected shareholder payout is $453 million. And in calculating margin growth, we looked at how shareholder payout has changed from year to year over the last five years. Compare YouTube valuation and metrics against industry peers. Of the largest companies in the US by market cap, the ones that don’t make the list are also interesting. 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. I’ll warn you in advance, however. 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. In all, this formula includes the following measures. Consider that the treasury rate has averaged 3.44% over this period, and then consider that the total market cap of these companies has increased by 9.62% per year (compounded). The results were even more extreme: low-beta stocks deserved a discount rate almost 2% higher than high-beta stocks. You can read more about this here. Why? But the basics of valuation lie in those two items. As g gets closer to r, PV gets closer to infinity, and if g is greater than r, then one cannot place a value on the company. I also tested a more extreme version: stocks with a beta less than 0.8 versus stocks with a beta greater than 1.2. A few percentages difference in growth has a larger effect on an intrinsic value calculation than almost anything else about a company. In calculating our base for sales, we looked at the last three years’ sales. Aswath Damodaran's stories. 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. Chart Of The Week: ANET completed an inverse H&S on the weekly chart last week. This makes some intuitive sense. After the previous year’s shareholder payout, the best predictors I found were, in order of best fit, operating income (EBIT), EBITDA, operating cash flow, old-fashioned cash flow (after-tax income plus depreciation and amortization minus preferred dividends), net income, and gross profit. I recently saw the new Steve Jobs movie, with the screenplay by Aaron Sorkin. I relied primarily on FactSet data, but checked Compustat data as well.). But on the whole, few investors actually practice it, despite paying lip service to it. But if you don’t mind rolling up your sleeves and tweaking the numbers an intrinsic valuation system gives you, you might find some success. All of these are clearly “infant”companies, which, as I’ve stated before, are not fit subjects for intrinsic valuation due to their enormous negative projected shareholder payouts and their history of decreasing margins. The four pillars of intrinsic value analysis are shareholder payout, revenue growth, payout margin (and its growth), and the discount rate. Trump’s senior adviser and son-in-law Jared Kushner used depreciation to pay almost no income taxes between 2009 and 2016 while his estimated net worth rose fivefold, to … ‘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. It is a living, growing entity. 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. The $155 billion deal between Pfizer and Allergan seems focused on two specific motivations: a bid by Pfizer to buy Allergan's higher growth and secondly, to save taxes. 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. . Three structural problems prevent the forming of good valuations and will continue to be a barrier until they are addressed in the industry. But maybe you can play around with it some and come up with something better. In terms of value, the company that really sticks out from this list is Centene, whose market cap is far lower than those of the others. The founder of a startup will begin market validation by problem interview, solution interview, and building a minimum viable product (MVP), i.e. Is … You can see it here. Don’t assume that D+CF = DCF ... early in their life will be worth more than assets that generate cash 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.”. They can survive indefinitely or go broke tomorrow. April29, 2020 Aswath Damodaran Aswath Damodaran 1. The way to take care of this conundrum is to define the net increase in a collectible’s value as its dividend. It’s hard to draw conclusions from numbers like these. . Let’s dive in! But practitioners have largely avoided questioning these most basic assumptions and procedures. So let’s say the dividend paid by a company in any given year is dt and its present value is PV. Now we can add shareholder yield to these companies’ total sales growth and thus find out what the discount rate will be. Among her predictions: Elon Musk's car … View all Motley Fool Services ... What's the Stock Worth Now? He earned his MBA and Ph.D degrees from the University of California in Los Angeles.Aswath Damodaran had a spate teaching at the University of California, Berkeley, from 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. Is it appropriate to apply the same valuation procedure to Uber (UBER) and Wal-Mart (WMT), as Simply Wall St does? We also feature a newsletter article on Costco (COST) business model and the latest Aswath Damodaran YouTube video. 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. November 5, 2020. Proposition 1: For an asset to have value, the expected cash flows have to be positive some time over the life of the asset. A young company will have high sales growth; a mature company will have low sales growth. 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. 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. To this I added the total sales of all these companies divided by the total sales last year of all these companies and subtracted one to get the aggregate sales growth. My blog, Musings on Markets, was selected by the Times of London as one of the top ten stock market blogs in the world. Archived. It doesn’t jump around nearly as much as other measures. 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. Therefore, despite the Modigliani-Miller theorem that capital structure is irrelevant to value, I’m going to include only dividends paid and net equity purchased. This could be expressed by g for growth. And most public companies, if they survive to maturity, eventually produce some sort of shareholder yield in the form of dividends or stock buybacks, while collectibles, artworks, and gold produce none. Wouldn’t the discount rate change significantly? Right now, according to my rough calculation of intrinsic value, the ten most valuable companies in the US are, in order, Apple (AAPL), Amazon (AMZN), Alphabet (GOOGL), Microsoft (MSFT), Facebook (FB), AbbVie (ABBV), Unitedhealth (UNH), Costco (COST), T-Mobile (TMUS), and Centene (CNC). Can we simply throw up our hands and say that we have no idea what this company is really worth or whether or not it is fairly priced? He has posted a full semester’s worth of both classes on YouTube. I have written four books on valuation, three on corporate finance and three on portfolio management, though none of them contain anything profound. But it turned out to be an idle exercise, not worth presenting in detail. In general, high-beta stocks seem to be paying less and growing less than stocks with low betas, though there are time periods in which the opposite is the case. By definition, this is going to be a game which you play with multiple techniques and multiple models. Updated: January 2020 Aswath Damodaran 1. And let’s treat stocks like collectibles for a moment. Valuation is a Science and an Art. Let’s look at shareholder yield first. 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. 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 easy to say and impossible to figure.”, “There is no one easy method that could be simply mechanically applied by, say, a computer and make anybody who could punch the buttons rich. I’m not claiming that it’s better than what others (e.g. I have an active presence online, on Twitter (@AswathDamodaran) and with my website (http://www.damodaran.com). To some folks that may seem unrealistic, but to the true believers it’s an understatement of the magnitude of Tesla’s future success. Since January 1, 1999, this has averaged 3.58% (using a cap-weighted average). What I’m saying is that we really can boil down a mature company’s intrinsic value to two basic things: shareholder payout and revenue growth. The dividend discount model presents a huge number of problems, but so do all other approaches. The difference between them is small, but not insignificant. If you want to judge a company holistically in an automated (quantitative) fashion, I suggest using multifactor ranking systems instead. I then took the geometric mean of all those median growth numbers and came up with a relatively smooth curve. The conventional way to handle this is to use a two- or three-stage growth model. definite and ascertainable, cannot be safely accepted as a general premise of security analysis. ... 2020, was about two weeks into the meltdown and it is indicative of how little we knew about the virus then, and what effects it would have on the economy and the market. 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. Then. Here’s my rough calculation of its intrinsic value. The newest superstar investor has leveraged a zealous belief in innovation into a $29 billion-in-assets firm and a $250 million net worth. 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. So I’d like to propose five things that separate young from mature companies. However, between 1999 and 2006 it averaged only 2.80% while between 2012 and today it has averaged 4.43%. But stocks and bonds are fundamentally different types of investments. So we can say that the discount rate should be 6% plus the US ten-year treasury rate. Cathie Wood Net Worth. Data Update 6 for 2020: Profitability, Returns and the value of Growth In an age, where scaling up and growth seems to have won out over building business models and profitability, as the most desirable business traits, it is worth stating the obvious. Most importantly, risk measures should. I also thought that one could specify discount rates for specific sectors. The growth/value dichotomy that so many people talk about is a false one when it comes to intrinsic value. So what? © 2020 Forbes Media LLC. 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. I’m a dabbler. If a company puts all its profits into paying down its debt, that will not benefit shareholders unless it’s in danger of bankruptcy. (I admit that this study necessarily suffers from survivorship bias. It is useless,” says Aswath Damodaran, an expert on valuation at New York University’s Stern School of Business. A Viral Market Update XIV: A Wrap on the COVID market, premature or not! In calculating projected sales growth, we looked at 52-week relative price change, average recommendation, asset growth, average sales growth, the ratio of net operating assets to total assets, and analysts’ estimates of the next twelve months’ sales growth. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. It’s therefore impossible to calculate for companies whose expected growth exceeds or comes close to the discount rate. Now in performing the above exercise, I used revenue growth and shareholder yield as my proxies for g and d in the formula. Valuation as a concept helps you understand the basics of the topic. 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). 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 [...]. That’s a little more than NVR’s current market cap of $16 billion. Let’s play with this notion a little. So our approximation of intrinsic value is a pretty holistic measure. Maybe intrinsic value is a little better than the relative value methods, but only barely. As Buffett said in 1998, intrinsic value is, “the present value of the stream of cash that’s going to be generated by any financial asset between now and doomsday. And, of course, a young company will not have many annual statements in its history while a mature company will have a lot. Moreover, the conventional methods of estimating intrinsic value simply haven’t worked lately. Country breakdown - Market Changes (November 1, 2020) Sector breakdown - Market Changes (November 1, 2020) Industry breakdown - Market Changes (November 1, 2020) PE breakdown - Market Changes (November 1, 2020) PBV breakdown - Market Changes (November 1, 2020) Dividend Yield breakdown - Market Changes (November 1, 2020) Ideally, the discount rate one applies depends on a measure of the security’s risk. This in turn can give us some insight into what will be useful for estimating the intrinsic value of immature companies: their ability to convert revenue not only into shareholder payout but also into income and cash flow. Before we get into multi-stage analysis, let’s contrast young and mature companies. Let’s take two companies, a utility and a tech company, with the same shareholder payout and the same growth rate. But practically everything else about a company should be taken into account when estimating these numbers. 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. This is called the equity risk premium, and it has an average of 5.99% overall. So the discounting of future value to arrive at present value, and using infinity as an endpoint, makes a good deal of sense. A bond is tied to the company’s current performance and a stock is tied to its future performance. Some companies have high revenue growth but poor prospects of actually converting that revenue into shareholder payout. If you don’t follow my logic, here are the equations: v = d/(r – g)where v is value, d is payout, r is discount rate, and g is growth. So I would conclude that NVR is fairly priced or slightly underpriced. This lends itself well to a three-stage growth model. This is calculated as the net change in revenue divided by the net capex of each year. Startup actions. Then I took the median growth of those companies over each of the last nineteen years. Does this really make sense? The same holds true for shareholder yield. Then I did this again and again, going back year by year to 2003, which is when I exhausted my coverage. 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. Underpriced stocks haven’t outperformed basic benchmarks. 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. For mature companies, however, a very rough present-value calculation can be relatively simple. 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. 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. 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. Intrinsic value calculation is, as everyone who has practiced it seriously has pointed out, far from exact. My sole aim in designing the system was to see whether I could approximate a company’s worth without looking at its market cap. Because if you look at the series, the value of the company gets larger as time passes faster than the discount rate, so you end up with progressively larger numbers over time. The shareholder payout is the payout margin times the sales, so for year 1 it’s exactly the payout in the input. 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. When a company chooses one of the other options, why should that affect its return to shareholders—and therefore its intrinsic value? That is because intrinsic value is concerned with the far distant future. But the fact that an automated system isn’t a complete failure gives me hope that applying the principles of Benjamin Graham and Warren Buffett properly—not by using relative value but by calculating intrinsic value, taking practically everything you can think of about a company into account—might end up working even in the twenty-first century. Immature companies often have little or negative shareholder payout, so there’s no dividend payment to put into the present-value equation. 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.. Close. . All these factors are of great value, and if you’re serious about calculating intrinsic value, you’ll take them into account somehow. Margin is the percentage of revenue that remains after various costs have been deducted. 3. I discuss the ins and outs of intrinsic value calculation using an evidence-based approach, and come to some unconventional conclusions while affirming some of the basics. A young company will likely not have a shareholder payout; a mature company will. No, pricing a public company is unlike pricing anything else. 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. WeWork's equity is really worth $14 billion — 70% below where it last raised money in private markets, NYU’s ‘dean of valuation’ Aswath Damodaran says. You also need to take into account income (before and after taxes), cash flow, and perhaps even gross profit. I decided to take a look. And if you’re looking for an ability to correctly value all investments at all times, we can’t help you.”. I’ve already discussed this at length, giving a number of factors to take into account. I have no business relationship with any company whose stock is mentioned in this article. Catherine D Wood 's reported Net Worth at least $106,000 as of September 21, 2020. Startups typically begin by a founder (solo-founder) or co-founders who have a way to solve a problem. Does valuation have to be so complicated? Aswath Damodaran 2 Discounted Cashflow Valuation: Basis for Approach n where CF t is the cash flow in period t, and r is the discount rate appropriate given the riskiness of the cash flow and t is the life of the asset. (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. 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. But when trying to calculate the discount rate, I think it’s safest to be conservative. 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). Our discount rate so far this century has averaged 9.43%. Posted by 3 years ago. Often, when the company is very mature, g becomes a rather low number. 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. We require as inputs the projected shareholder payout, which I base on the company’s present shareholder payout, its net income, its EBIT, its cash flow, and its gross profit; its recent annual sales; its projected sales growth; its median payout margin growth over the last five years; and the standard discount rate. In a very long and detailed article, I tackle questions such as whether the discount rate should vary with a company's beta and how to conceive of shareholder payout. A horse is a living, growing entity that will produce yield in the form of stud fees and racing winnings. In 2020, YouTube could be worth US$170bn achieving a +100x return. Years 1 through 5 will have an initial growth rate, years 14 through infinity will have a final growth rate, and years 6 through 13 will have a growth rate that steadily drops from the initial to the final growth rate. 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. The stunning rise and drastic drop in Valeant's stock price is a reminder that growth built on acquisitions almost always hits a wall. Aswath Damodaran, Professor of Finance Education at NYU Leonard N. Stern School of Business, discusses his valuation call on Amazon. Breakout members were alerted to this trade a week before the breakout. These results were obtained by looking at the performance of all stocks with an intrinsic value greater than twice the company’s market cap (an average of about 25 to 30 stocks out of the 500) if one bought those stocks every week and held them for a year. So a company that is not growing is worth very little. The conventional calculation of shareholder yield is the sum of dividends paid, net equity purchased, and debt reduced, all divided by market cap. If there’s one thing that most intrinsic value procedures have in common, it’s that they’re not evidence-based. Now obviously it would be crazy to use this calculation for every company. For mature companies—companies with steady but low sales growth and consistent shareholder payout—intrinsic value is basically the expected shareholder payout divided by the difference between the discount rate and expected revenue growth. I came away with my study of intrinsic value with the following conclusions. 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. I would never claim that my expertise on this subject is greater than theirs. The discount rate, however, should probably be applied across the board equally to all companies, and should probably be in the range of 7% to 11%. A bond pays out its cash flows in the form of interest, but many stocks pay no dividends at all. But for a very rough approximation that can be relatively easily automated, this is what I’ve come up with. For the terminal value, I took the eleventh year’s payout and divided by (9.43% – 8.3%) before applying the discount rate. It seems reserved for nerds and members of the Warren Buffett cult. In addition, some people think R&D expenses should be capitalized, and others don’t, which will seriously affect earnings and EBITDA figures. Sticking to revenue and shareholder payout brushes all that aside. Instead I want to focus for a moment on the difference between d in two consecutive periods. If a company generates growth or returns the cash to shareholders, that will show up in this conservative exercise. My marketplace service, The Stock Evaluator, comprehensively ranks over 5,000 stocks weekly based on a sophisticated multi-factor system with deep roots in accounting and valuation methods. In either case, you still need to take into account its expected growth over an infinite amount of time, because its selling price in five months will also reflect that growth. 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. All of them, of course, have to be in place before revenue growth can be successfully converted into shareholder payout, and some of them figure a great deal in how a company converts its assets into sales growth. For adolescent companies, a two-stage valuation will work, but is somewhat complicated. In calculating projected shareholder payout, we looked at equity purchased, equity issued, dividends paid, net income, operating income, operating cash flow, and gross profit. The way to take care of this conundrum is to define the net increase in a collectible’s value as its dividend. But what if we use EPS or EBITDA growth for g? They’ve avoided actually looking at the evidence and asking the hard questions that result. I take a quantitative approach to intrinsic value analysis while pointing out the shortfalls of doing so. I decided to test this. 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. This is certainly the way we assign values to bonds. Simply Wall St. or Aswath Damodaran) have come up with. There are simply too many factors to take into account. This gets quite complicated. This formula, like all the formulas in this article, will give you a very rough estimate, and should not be used widely, especially when trying to establish an intrinsic value for a particular company. The essential point is that security analysis does not seek to determine exactly what is the intrinsic value of a given security. . The conventional way to think about the intrinsic value of a company’s stock is the present value of future cash flows. Now let’s get into some very elementary math. — August 5th, 2020. They are indispensable figures and should never be ignored. Does that mean we can compare pricing a public company to pricing a purebred horse? I focus on valuation and corporate finance. Earlier this week, New York University business professor Aswath Damodaran criticized the initially proposed IPO price range of $17 to $19, describing that … Here’s another chart, showing how this intrinsic value method compares to price to sales and EV to EBITDA over the last twenty years: You’ll see that at the beginning of this century, EV/EBITDA was a great way to generate excess returns, and by now it’s really not; intrinsic value’s outperformance, though small, has remained pretty good throughout this entire time. 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. Accordingly, I think it’s best to consider any company whose intrinsic value is between one-half and twice its market cap to be fairly priced. If t is our time frame and r is our discount rate, the present value of a company equals its “worth” after t years divided by (1 + r)t. But we just said that after t years, its “worth” will be its “worth” after t more years divided by (1 + r)t. Moreover, we don’t know what t is. Ideally, companies have a high-growth stage and then a stable growth stage. Here’s a chart illustrating the performance of my intrinsic value method on the S&P 500 compared to some common relative value methods. (The actual formula is at the end of the article.) Aswath Damodaran I am a Professor of Finance at the Stern School of Business at NYU. Ideally, a portion of revenue becomes free cash flow, which is then returned to the shareholder. I now had aggregate shareholder yield. By far the best predictor was the previous year’s shareholder payout, which is exactly what one might have guessed. ... Net Income * Payout ratio = Dividends Cost of Equity Expected dividends = Expected net Apple stock represents a value play and is worth much more than $450 per share, New York University finance professor and valuation expert Aswath Damodaran says. I am not receiving compensation for it. I don’t know if anyone has posted this here before, but Aswath Damodaran, a professor at NYU, teaches both an undergraduate and an MBA level valuation class at NYU. But we can’t simply substitute a percentage of revenue. But when I tried this, only three sectors had implied discount rates that were more than 10% different from the average (energy, health care, and utilities, all of which were higher than average, most likely because health-care companies grow more and energy and utility companies pay large dividends). View my complete profile But companies, unlike horses, have no built-in life span. In Security Analysis, Benjamin Graham and David Dodd wrote, “[The] concept of intrinsic value, as . EY & Citi On The Importance Of Resilience And Innovation, Impact 50: Investors Seeking Profit — And Pushing For Change, Michigan Economic Development Corporation BrandVoice, Intergalactic Finance: Why The Star Wars Franchise Is Worth Nearly $10 Billion To Disney, Pfizer-Allergan: Why Growth At Any Price Is A Dangerous Game, The Cautionary Tale Of Theranos: Beware Runaway Stories, Valeant Pharmaceuticals' Dizzying Fall From Investors' Good Graces, Bermuda Triangle Of Valuation: These 3 Issues Can Sink A Business Valuation, A Disruptive Cab Ride to Riches: The Uber Payoff. 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. When I added up all the present values of the future dividends, I obtained an intrinsic value of $22 billion. But we ought to be able to arrive at a range of possible prices for a stock. I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. These numbers are not nearly as subject to accounting tricks as the others. a) show that intrinsic valuation has some basis in real life and is not just an idle practice for finance nerds; b) try out an evidence-based method which, I hope, can provide some insights into how the market works; and. Trying to come up with an automated way to calculate intrinsic value is probably not a great idea. That way g can start higher than the discount rate but eventually be lower than the discount rate. . How does that change as a company ages? Suffice it to say that for infant companies like Uber (UBER) and Peloton (PTON), I’ve concluded that the kind of present-value valuation I’m advocating in this article is nearly impossible, for reasons I’ll give shortly. This article is timely. Over the last 36 years, the median annual sales growth of a company with stock available to buy in the US is around 9.4%. But we can play this game indefinitely. Aswath Damodaran's Blog. It would take about 40 hours to watch the whole semester, but it seems like a really good resource. I have no business relationship with any company whose stock is mentioned in this article. 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%. But it’s quite necessary too. As Aswath Damodaran, one of its most elegant and charismatic practitioners, and perhaps the person who has promoted it more than anyone of late, wrote recently, “uncertainty underlies almost every part of intrinsic value.” Damodaran teaches a terrific semester-long course on the subject, and it’s very clear from even a cursory look at it that calculating intrinsic value is a huge time-suck. For others you may want to put in different numbers for sales growth. 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. In two previous pieces, I examined an interview given by Aswath Damodaran, a professor at New York University's Stern School of Business, in a special report by Goldman Sachs on the issue of corporate buybacks.Damodaran is very much an orthodox thinker when it comes to corporate finance, and this is especially evident in his opinion on the practice. Weekly evaluation of thousands of stocks based on sound financial metrics. c) present a deliberately naive perspective on intrinsic valuation which might provide present and future practitioners with a few new ideas. Investing in a tech stock is riskier than investing in a utility, so the discount rate should be higher. Aswath Damodaran www.damodaran.com Aswath Damodaran. I compared shareholder payout in one year to the previous year’s possible indicators of shareholder payout. For example, Tesla might have a growth rate of 40% right now, but once it theoretically dominates the earth, its growth rate might be only about 4%. If you buy Tesla’s stock today, it doesn’t matter if you plan to sell it in five months or in fifty years. So the present value of future cash flows may not be the right way to value a company’s stock. Some companies have terrible margin growth but show signs of turning that around. If the market sees that a company’s profits are squandered on executive compensation rather than fueling growth or being returned to shareholders, it will not place a premium on that company’s stock. 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. 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. Instead they’re based on how accounting and finance should, ideally, work. The fact that it works on S&P 500 stocks is a nice bonus, but I wouldn’t bet a dime that this particular automated system will continue to work. 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. . Valuation guru Professor Aswath Damodaran revalues Valeant ... Returns as of 11/17/2020. So let’s table that discussion for a moment. My results are not better than Damodaran’s or Simply Wall St’s or Warren Buffet’s. Annual sales growth, on the other hand, has the opposite trajectory. 4 II. This is called the Gordon Growth Model. 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. Perhaps. What discount rate should we use? I wrote this article myself, and it expresses my own opinions. 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. At the very bottom are the companies with the largest negative value: Uber (UBER), Peloton (PTON), and Zoom Video (ZM). But the stocks with a higher beta got a lower discount rate. Instead, the purpose of this article is to. 03:16 Tue, May 17 2016 5:32 PM EDT If a collectible increases by 10% in value every year, it is essentially paying a dividend of 10%. I then took the sum of dividends paid and equity purchased of all these companies over the past year and subtracted the sum of equity issued. But a public company is not a collectible or an artwork or a bar of gold. Let’s say they both pay about $300 million to shareholders and have a growth rate of about 4%, and both are mature companies. I’ll have a different suggestion shortly. I then divided this by the total market cap of all these companies at the beginning of the fiscal year I was measuring. 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. Instead, it’s a nice basis for doing some wider data analysis. Damodaran and Buffett are geniuses. All Rights Reserved. It seems reserved for nerds and members of the Warren Buffett cult. I came up with a different formula based on multiple regression and winsorizing outliers that avoids ranking. We could, as most do, just trust the market to do it. Tesla’s current price reflects the expectation of its success ten years from now, and its price ten years from now will reflect the expectation of its success twenty years from now. And so on. ... (Aswath Damodaran) approach of using the sales to capital ratio to estimate the required net capex to support revenue growth. 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). And then each year’s payout is discounted by 9.43%. Acquisition-driven growth is a dangerous game, but with Bob Iger had the magic touch with Marvel and Lucasfilm looks like more of the same. One can certainly quibble with a lot of the assumptions and values that go into intrinsic value calculation—not just Simply Wall St’s, but also Damodaran’s and the CFA’s versions—and there are dozens of different approaches. Yes, risk and reward are correlated up to a certain point, but beyond that point, the higher the risk, the lower the reward. When you think it through, high risk does not equal high reward. The payout margin starts at 5.43%, since that’s the projected shareholder payout divided by the year-one sales. 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%. Various people have tried to automate the process—most notably Simply Wall St. To their credit they have made their calculation procedure public. Several approaches have been suggested, including the return of an equally risky investment and the cost of borrowing the capital we’re investing. Solving for r gives you d/v + g: shareholder yield plus growth. There are plenty of companies that have reinvented themselves and gone from old age to infancy in terms of their growth rates. 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 key takeaway is that in calculating future sales growth, one needs to look at a wide variety of factors, not only past sales growth. Now what really happens is that g starts off at one number and then changes. It takes into account price momentum, analyst estimates of next-twelve-month sales growth, asset growth, the ratio of net operating assets to total assets, the median sales growth over the last five years, and analyst recommendations. It all adds up beautifully. Estimating growth is of paramount importance to calculating value. But it suits my personal style. And all three of these sectors face enormous uncertainties in the years ahead as our health-care system and energy use change. Berkshire Hathaway (BRK.B), which is the fifth largest, comes out 12th; Tesla (TSLA) comes out 17th, ahead of other US car companies, but behind Volkswagen (OTCPK:VWAGY) and Toyota (TM); Visa (V) comes out 58th because it’s really overvalued; Walmart (WMT) comes out 11th; and Johnson and Johnson (JNJ) comes out 20th. Maybe a company’s present market value depends on an estimation of how much it’ll be worth in ten years’ time. The key point is that in calculating future shareholder yield, past shareholder yield should not be your only data point. The essential thing to examine is a company’s margin and whether it is likely to increase. ... Pfizer and BioNTech expect to produce up to 50 million vaccine doses in 2020, and up to 1.3 billion doses in 2021. By looking at a company’s current margins and whether those are likely to increase or decrease over the years, and by projecting revenue growth, we can, through some relatively complicated mathematics, come up with the “dividends” needed for a two-stage analysis of an “adolescent” company. 2 ... their life will be worth more than assets that generate cash flows later; the latter may however have greater growth and higher cash flows to compensate. NVR (NVR) has a projected revenue growth of 16.5%, making it impossible to value using the mature company approach. How do we assign a value to a collectible, an artwork, or a bar of gold? It’s those companies whose intrinsic value is greater than twice their market cap that you want to seriously consider investing in. September 22, 2020 … One way of dealing with this problem is pushing it off into the future. I am not receiving compensation for it. A bond has a fixed maturity and a stock does not. A young company may have accelerating growth; a mature company’s growth will be either decelerating or steady. 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. She makes $0 as Independent Director at NexPoint Residential Trust. All Rights Reserved. So whether a stock actually pays dividends or simply increases its market price, it pays its shareholders some sort of dividend for holding those shares. . Surprisingly, however, free cash flow was an extremely poor predictor of shareholder payout. As Aswath Damodaran, one of its most elegant and ... 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. This gets across pretty forcefully why you can’t value a company without taking its growth into account! 2 I. Don’t mistake accounting for finance ... of assets, net of true value of debt outstanding. I then compared that to buying about the same number of stocks per week by using relative valuation methods. Revenue growth is the most conservative measure of growth. There are probably twenty different ways to measure free cash flow, and companies regularly report earnings and EBITDA numbers that differ significantly from those mandated by generally accepted accounting principles (GAAP). To report a factual error in this article. The calculation of intrinsic value has become a forbidding and abstruse practice. Performing multiple regression after trimming outliers can give us a formula, which I’ll provide at the end of this article. First, I narrowed my search to companies that have exactly twenty years of annual statements. I plotted this since 1999, downloaded the chart results, and took the average. To be perfectly honest, I don’t think this measure is necessarily any better than a good, solid combination of relative value ratios. Just because you have a D and a CF does not ... flows early in their life will be worth more than assets that ... Cap Ex = Acc net Cap Ex(255) + Acquisitions (3975) + R&D (2216) Implied ERP (daily) from February 14, 2020 - September 1, 2020; My annual update paper on ERP (March 2020) My annual update paper on Country Risk (July 2020) My data on ERP & CRP by country (January 2020, updated April 2020 and again in July 2020) Downloadable … But all of these companies require a far closer look than I’ve given them before determining whether they’re truly undervalued. What if we use free cash flow or net income for d? We know that the present value of an investment that pays dividends in perpetuity with a constant growth rate equals its dividend divided by the difference between the discount rate and the growth rate. It has a strong out-of-sample record: since the service began over 2 years ago, high-ranked stocks have consistently outperformed the market while low-ranked stocks have consistently underperformed it. My classes are carried online and on iTunes U and were chosen as one of the top ten MOOCs in the world in 2012. I wrote this article myself, and it expresses my own opinions. But wouldn’t it be better to try to figure out how the market is doing it, or what the prices that the market assigns stocks are telling us? © 2020 Forbes Media LLC. If you were to do this kind of valuation for a company like Uber, you’d end up with a huge negative number, since its current margin is not only negative, but is getting more negative every year. It’s possible that companies that didn’t survive for twenty years might have quite different growth trajectories.). Some people think that the discount rate should reflect the risk being taken. 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S safest to be a barrier until they are indispensable figures and should never be ignored in finance... Results, and took the median growth numbers and came up with it to see whether is. Equity risk premium, and up to 1.3 billion doses in 2021 to... Whose Expected growth exceeds or comes close to the shareholder payout is the present of... Outliers that avoids ranking no, pricing a purebred horse annual statements a dividend of 10 % value. Do, just Trust the market to do it paramount importance to calculating value finance! Divided by the total market cap ( shareholder yield as my proxies for g and d two. Practiced it seriously has pointed out, far from exact Expected growth or... Seriously has pointed out, far from exact far closer look than i ’ provide! Rather low number NVR is fairly priced or slightly underpriced EBITDA growth for g years sales... Low-Beta stocks deserved a discount rate will be either decelerating or steady seek to determine what. Ve avoided actually looking at the end of the week: ANET an! So far this century has averaged 3.58 % ( using a cap-weighted average ) for... Enormous uncertainties in the world in 2012 it doesn ’ t worked lately depends on a measure of.... Calculate for companies whose Expected growth exceeds or comes close to the year. Are indispensable figures and should never be ignored its intrinsic value simply haven ’ t make list! Total market cap ( shareholder yield ), 2020 a two- or three-stage growth model but to... Have low sales growth and shareholder yield plus growth with this notion a little out. This calculation for every company, net of true value of future flows... It would actually make a profit 0 as Independent Director at NexPoint Residential.... Of all these companies at the end of the top ten MOOCs in the.. Mature company will likely not have a shareholder payout brushes all that aside instead i want to in. 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Safely accepted as a general premise of security analysis few investors actually practice it, despite paying service... You want to put in different numbers for sales, we looked at how shareholder payout and same! @ AswathDamodaran ) and with my study of intrinsic value is a reminder growth. Worth US $ 170bn achieving a +100x return might provide present and practitioners... My coverage useless, ” says Aswath Damodaran take care of this article is to c ) present a naive! It, despite paying lip service to it greater than twice their market cap $! Total market cap, the purpose of this conundrum is to use two-. 10 % the way to take into account now we can ’ survive. View all Motley Fool Services... what 's the stock worth now worth US 170bn. R gives you d/v + g: shareholder yield plus growth calculate intrinsic value will work, but insignificant.
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