An authority on valuation and applied corporate finance, Aswath Damodaran, professor of finance at Stern School of Business, New York University, says a lot of uncertainty in the market creates bargains. In an interview with Saikat Neogi, he says investors should make bets across stocks and be willing to accept mistakes. Excerpts
How should a long-term investor looking for bargains value companies when there is so much future uncertainty?
The same way he would when there are few uncertainties: doing his homework, making the best judgments given the information he has and valuing the company. In fact, you want a lot of uncertainty because that is what creates bargains in the first place. In the face of significant uncertainty, a little humility is good. Remember, you will be wrong almost all the time. Spread your bets across stocks and be willing to accept your mistakes.
Indian stocks have been on a roll for over a year now. How do you see their valuations compared with that in other emerging markets (EMs)?
Much of the upswing in value comes from the expectation that with the right policy changes, India has promise. With Russia in isolation, Brazil wrapped up in a corruption scandal and China slowing, this may be India’s moment (though it will be fleeting). Like all upswings (or downturns), investors have probably been indiscriminate in how they have marked up (or down) stocks. The policy changes, if they come, will create winners and losers and I am not sure the market is building in this expectation into prices.
What are the risks that Indian equity investors need to be cautious of?
In the short term, the biggest danger is a momentum shift — investors who have ploughed into the market in the last few months turn tail and run in the opposite direction. In the medium term, inflation will surge, especially if economic growth is robust, and political momentum for change will slacken. In the long term, woeful investment in infrastructure (power, transportation) will come back to haunt the country.
If another investment cycle gets going in India, like the one over 2002-09, should investors start owning more equities at the current valuations?
For the Indian investor, the answer is no — the average Indian investor is overinvested in Indian stocks (for no fault of his own). Foreign investors already own far more Indian equity than they did a year ago, partly because the value of their holdings has gone up. This will happen on its own if the economy continues to be robust.
This year, foreign portfolio managers have been putting more money in Indian debt than in equity. Is it because debt in India has better valuations vis-a-vis other countries?
Three reasons. The first is interest rate illusion, where low rates in the US and Europe are sending bond funds on a global search for higher yields, and India offers those right now. Second, portfolio managers chase both other portfolio managers and market momentum. Third, Indian firms are just starting to tap the bond market (as opposed to borrowing from banks) and the rates they are paying may reflect the youth of the market.
Often, investors go for value companies with a history of profits and a well-established business model. As such, they are unlikely to find great bargains. How should an investor avoid the obvious in valuating companies that don’t have much history to boast, but have great future potential?
Don’t fall for the hype from managers and analysts. Be wary of macro stories. Weigh the company’s competitive advantages and whether they are sustainable. Also, focus not only on the promising company but on how competition, customers and the market is changing. Often, investors seem to value promising companies as if they were the only players in the game. Don’t let people tell you that these companies cannot be valued.
Do you feel the long-term potential of EM equities remains high with rising urbanisation and an expanding middle class?
Perhaps, but I don’t think all GDP is convertible into domestic market cap, especially in a world where global companies dominate. The connections between a country’s GDP and its local market cap will only weaken over time.