Prof G Markets: First Quarter Review — with Aswath Damodaran

25:11You could still see the arrogance of we're a growth company. We can go to the metaverse. We can do all kinds of stuff. And I've got to give Mark Zuckerberg credit. I mean, he's in a sense grown up quickly, partly because he got punished by the market so intensely. But I think that is to me a big story because it tells me that these companies are laying the foundation. Because when you pay dividends, what you do is you change your investor base. You're calling in people into your investor base who traditionally might have stayed away from you, more value-oriented investors. and they might bring a lower price, but they also bring in more stability.

25:49These are not the people who are saying, what have you done for me lately? When are you going to deliver 20 % growth? And that's why it's a big story because I think they're preparing an investor base for a more sobering decade going forward. In spite of all the bubbling of AI right now, looking forward, I think they see more competition, less growth, and I think that paying of dividends signals that that's what they're seeing. Just a quick follow-up specific to dividends. Amazon is the only one you mentioned there that did not issue a dividend, but the rest of tech has, Google, Microsoft, NVIDIA, Apple.

26:25Amazon's done, you know, more than$50 billion in free cash flow in the past 12 months. Do you think they'll issue a dividend anytime soon? They're the odd man left out. I mean, I think, you know, it's a question of, I think, what the price does and how the market reacts to it. And I mean, I think they might be, you know, it might make sense for them to, I mean, remember these dividends are not big dividends. They're almost like, you know, first rounds in a much longer fight. So I think if Amazon wants to get a more mature, and I'm going to use the word with quotes around it, investor-based, this might not be a bad idea because I don't think you want, the kinds of investors who invest in GameStop and AMC buying your stock because they might push your stock up 30 % quickly, but they can also push your stock down 30 % for no good reason at all.

27:19So I think that there is a significant portion of our investor base which has gotten used to this, playing investing as a game. They're playing the same way they do casino tables. And if I'm a company, I want those investors away from my company, not in my company. So Aswath, it's interesting what you said about, you sort of couched the announcement to issue a dividend, not as a negative thing, but almost a signal sobriety or the days ahead might not all be champagne and cocaine. Something I learned from you, though, is that it reflects maturity to recognize you're no longer a teenager. And that if your core business is so strong and is spending off so much cash that it's unlikely you could start a new business or make an acquisition that could offer the same cash flows as your current business, that it's a fairly efficient way to return capital to shareholders.

28:15Is that, I mean, to me, I saw this as a good sign. Do you have any evidence or research that shows the performance of companies pre and post when they launch a dividend? In fact, when you see companies initiate dividends, it's often, and you look at earnings growth before and after, earnings growth peaks about two quarters before dividends get initiated. And after that, what you see is earnings growth get much lower. So I think in a sense, dividend initiation is really a signal of, hey, guys, we got used to 20 % growth in our earnings. We're a different company now. And we want you to recognize that going in.

28:50And it's a sign of maturity to recognize that going for a higher price now and pushing up expectations that you cannot deliver is actually a bad thing. And I think these companies have come to that recognition. And I think that dividend payment might be the start of that process of kind of reorienting people's thinking about what the future will hold. I didn't think I'd be able to recommend these stocks after their huge run up. And then when I see that their cloud business, which they have made just staggering, I think we read or saw that across the big seven or the Magnificent Seven, they've invested something like$32 billion just in infrastructure around AI.

29:33You have the hottest growth segment in the world, AI, which every company wants to explore, build their own LLMs, but they can't build it themselves. So they need to rent it from a cloud-based provider. in order to be a cloud-based provider that can make the requisite investments to attract these types of clients, you have to make multi-10 billion dollar investments. So it's sequestered to just a smaller and smaller number of firms. One, it strikes me that the champagne or the nitro and glycerin of cloud and AI built on top of cloud means that the entire world's growth expenditure, corporate world growth expenditure, is going to be fundled into literally a small handful of firms, which is one, great for those shareholders, but two, begs the question, is this yet another speedballing of concentration of power where we should start thinking about antitrust?

30:30I mean, who's going to be able to compete with these guys? You know, it's been one of my worries with AI. I think this winner-take-all phenomena we've been seeing build up over the last two, three decades, which I think you pointed to when you first looked at the tech companies. AI, I think, is going to make it even more winner-take-all. And I'm sure in the Clayton Christensen argument about disruption 30 years ago that it always comes from outsiders, and that's the way it worked out with dot-com. With AI, I don't think that's going to apply. And here's why. You need two big things for AI. You need processing power in immense amounts and control of data.

31:13So it's going to be very difficult for a newcomer to even venture into the space because you're going to get squashed. This is one of those things where the biggest tech companies might actually start off at such an incredible advantage over everybody else that, you know, they're going to be, it's going to be tough to catch up with them. So the MAG-7 might have an extended run or the FANG-AM, if you prefer to call it, might have an extended run because AI actually makes the strong even stronger, just like COVID made the strong even stronger. This seems to be another phase of the strong will gain strength.

31:52There might be a newcomer who creeps in. But the interesting thing about the MAG-7 is when one of the companies underperforms, Apple, for instance, somebody else steps in and fills the gap. So it's almost like, you know, you hold all seven or all 10 or whatever you make the number that the collective group finds a way to outperform the market. Because if there's a loser that the winner often is another company in the same group, it's not some outsider that's coming in. So I worry that 20 years from now, you're going to look at the S &P 500 and you're going to find even, or any index, you're going to find even more concentration at the top than you did, which creates social and economic questions that will get bigger over time.

32:40So if you think antitrust is, and Alina Khan might think they're big, that question is only going to get bigger five years from now, 10 years from now. And it might become even more difficult to confront as these companies get bigger. Along those lines of, I mean, there's concentration, sort of seven companies within the S &P or within the NASDAQ. One of the things I've been focused on a lot, and some of this I gleaned from you, is just the power of diversification. You know, the number one question I get is, is it too late to buy NVIDIA? And I always say, I don't know, but if you buy an index fund, 33 cents on the dollar are going to the Magnificent Seven because they're weight adjusted.

33:20And if the other 493 companies have their day in the sun, you got 67 cents in those. What I haven't done or I haven't done much of is I haven't diversified geographically. And it strikes me that if you think about AI, I think we're 97 % of the revenue and 140 % of the profits within, not only within the US, but within a seven mile drive of SFO International. Do you tell people, I know you tell them to diversify, but do you think it's a bad idea to be pretty much all in on American markets? I'll tell you the biggest problem we have. I mean, I was in Latin America last week and I was in Brazil two weeks ago.

33:56And I took the top 20 companies in the U.S. and I put the ages of those companies right next to the companies. And a lot of the companies are 15, 20 years old. Facebook, if you think about it, is not that old. And then I took the top 20 companies in Latin America and I put them up. And they're ancient. They're, you know, and I did the same thing with Europe. ancient companies. You do that. I mean, the U.S., in a sense, is the outlier in this in terms of young companies not just breaking through, but making it to the top. I think the more the EU acts, the more convinced I am that Europe will never be a player in AI because in the interest of protecting consumers, they've actually created a system where if you of a young, smart person who's got this incredible AI idea in Europe, he's going to get on a plane, fly to Silicon Valley.

34:50And it's not just that if you look at the total global market gap, the U.S. has actually increased its share of that global market gap significantly. And with China falling, you actually are getting an even larger segment of global market gap coming to the U.S. So even if you held a global index fund, you're going to end up being over-invested in U.S. stocks because U.S. equities are just taking an increasing slice of global equities. But I don't even think of these companies as U.S. equities anymore. I mean, they might have, through the accident of history, become incorporated in the U.S. But these are global giants, right?

35:29They happen to be U.S. companies. So when you buy the S &P 500, you're buying global companies that happen to be U.S.-based. So I think of my portfolio primarily now as global companies. And to the extent that global companies, the fact that most of them are U.S.-based, I think reflects the way the rest of the world seems to be allowing or not allowing companies to catch up with the 21st century. And I think with U.S. companies, you're seeing that explosion of young companies take off. That's a plus of what's happened in the U.S. that the minus is when you have these young companies explored, you're going to create bit.

36:10I wouldn't be surprised if within my lifetime, and probably sooner rather than later, you get the first trillionaire. It's only a matter of time before it happens. So I think you're going to see all those side effects as well. Greater, you know, in terms of income, wider disparities in income, you know, and, you know, we have to be prepared for the consequences. Just on that idea of the concentration of power, something Scott and I have been talking about recently is this idea of interlocking board directors. Basically, you have a board director on one company, and then they're also at the same time a director of a competitor, or they have some sort of financial interest in a competitor.

36:54and you know my feeling is that this is pervasive in ai just as the examples we've looked at you know microsoft is involved in open ai but also mistral and also inflection reed hoffman is the co-founder of inflection but he's also on the board of microsoft brett taylor's the chairman of open ai is also on the board of salesforce which is invested in anthropic mistral it's basically probably all drink in the same bar and they stay at the same hotels right i mean it's a very incestuous component to this. But I think that we get the corporate governance we deserve. I mean, in 2004, when Google went public and they said, we're going to have two classes of shares, one with 10 times the voting rights, they were breaking from the back because for a century in the US, we were moving away from that model.

37:43Because the New York Stock Exchange said, if you want to be listed in the exchange, you cannot have two classes of shares. When Google announced they're going to have two classes of shares, I expected institutional investors to rise up and revolt and say, this is not something that's acceptable. But that's not what we saw. We saw institutional investors say, that's OK, because you guys are well-run and well-managed. It's almost like they were saying a benign dictatorship is OK, because they're benign dictators. Facebook is a dictatorship. I don't even know whether it's benign or malignant, depending on what you think about Mark Zuckerberg.

38:18But we allowed Mark Zuckerberg to have the kind of power that he did because as investors, we look the other way. Now, I remember in 2019, at the peak of Facebook's issues, a money manager complained to me that Mark Zuckerberg, I mean, he had a big stake in Facebook. He said, Mark Zuckerberg is not listening to me. And I said, you know, buying shares in Facebook and complaining that Mark Zuckerberg is not listening to me is like getting married to a Kardashian and saying, you know, Cameras keep following you all over the place. What exactly did you expect when you married into a reality shows family?

38:55Now, investors, in a sense, have looked the other way with tech companies in terms of corporate governance. And what you're talking about is a slice of that issue. Corporate governance is dead at tech companies. If there's going to be change here, it's not going to come from the board of directors pushing for it. It's going to come from outside. and it's going to come almost entirely from the price dropping enough that they care. The reason Mark Zuckerberg woke up after that metaverse fiasco is because the stock price dropped so much. So I think it's unfortunate because we talk the talk about corporate governance.

39:31We started measuring corporate governance 20 years ago with scores, but we've actually let corporate governance become worse because we spend more time talking about it then following through with actions. We'll be right back.

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41:28We're back with Prof G Markets. Just a pivot to entertainment and the content world. Love to get your general reactions to this paramount drama. The lunatics are running the asylum is my reaction, right? I mean, this is exactly why you don't buy into benign dictatorships, right? Well, sorry, before you comment, let me just set the stage for our listeners, which is, you know, Paramount, they've been fielding offers from several buyers, including Skydance Media, which we've discussed, Apollo. And then a little over a week ago, we learned that their longtime CEO, Bob Backish, is now leaving the company.

42:05And he's been in this, it appears, a spat with the controlling shareholder, Sherry Redstone, who controls it through her company, National Amusements. I just wanted to set that stage. Asworth, go ahead. Thank you. I mean, I think we need to go back to the original sin, which was when Subner Redstone was given these voting shares, the reaction was, he's such an insanely good manager. So what harm is there in giving him controlling power in perpetuity? And at that time, I remember thinking, but he's a human being. He's going to get older. And he did. And he got dementia. And the voting rights still stayed with him.

42:46they passed on to. So what we're seeing is the residue of decisions made in the 80s and the 90s. So what if Zuckerberg becomes, I mean, he will get to be 80, 85. What if he gets dementia? Who's going to be running Facebook? This is a problem we set ourselves up to repeat on all these big tech companies with voting shares with different, or shares with different voting rights. And Sherry Redstone is, you know, let's face it. I mean, she is eccentric to, you know, that's the right word. And, you know, she might not listen to reason, but she has controlling power. So we know the entertainment business.

43:29We need to consolidate that this business is in disruption. You can't do the things you used to. And there are only three players outside of Netflix. It's Disney, Warner Brothers, and Paramount. And the question is, where will they go? Because everybody else is going to be a side player. What I saw happen with Sherry stepping in and push, you know, you know, essentially putting a stop to this process is, you know, you're devising a pathway to drive Paramount into essentially ruin if you don't do something. That's not a whole lot you're going to be able to do as Paramount shareholders because of something you did 25 or 30 years ago.

44:09And I want this almost to be etched into people's memories the next time some company comes along with voting and non-voting shares. Yeah, but they never remember. We need to make a Netflix movie about Paramount in the years after and say, hey, watch this movie over and over again in case you're tempted to do it. Because it's funny at one level, but I think about all the jobs and the content you're putting at risk. It's a tragedy in the making that was born out of a corporate governance fiasco. At some point, do you think about running into the fire? I mean, Warner Brothers' discovery is now sub$8 a share.

44:51It's got a market cap of$19.5 billion. Now, granted, its enterprise value because of the debt is much greater than that. I think it's got about$40 billion in debt. But at some point with a company like Paramount or Warner Brothers, when they begin trading as if they're going out of business. Isn't there real upside potential there when these things get left for dead? I'm amazed that, I mean, maybe it's a governance issue that an Apple, I mean, because Apple could buy this with petty cash, right? Any of these companies. And if you think about buying content for entertainment, you're effectively getting an entire library with each of these companies that you can find better ways of using than each of these companies are.

45:30So we talk about winners getting bigger. This is going to be the next phase is I have a feeling that a lot of the existing entertainment companies are going to become parts of the big tech companies. And, you know, you mix it up with all the other things that come with these companies. It's kind of a terrifying thought, but you're getting your news from Apple, your entertainment from Apple. I mean, I think it's only a matter of time. I think the only reason the big tech companies are avoiding it is, do you really want to buy Paramount and have to deal with Cherry Redstone. I think unless you find a way to separate her from the company, no tech company will touch Paramount.

46:14So it's almost as if the presence of some of these existing people in the company makes them toxic enough that nobody wants to touch them. But you're right, at the right price, somebody is going to be tempted. And it's a morbid thought, but time sometimes takes care of some of these problems. So I'd keep a good watch on Sherry Redstone's health because that might be the dividing line of what happens to Paramount. And we've been talking about pretty high profile companies. Are there any sectors or companies that you're looking at where you think they've been kind of overlooked and you see something interesting in the markets, either overvalued or undervalued?

46:52I've been tracked, I mean, as you know, track markets on a monthly basis looking at the equity risk premium. And April, when I did the update, April 1st, it was peak momentum for markets. Everything looked amazing. If you remember, the story was inflation has been conquered. You know, Fed's going to cut rates. The economy is back. And four weeks late, it's amazing how much the mood has shifted on big questions, right? All of a sudden, there's this worry about, is the economy as strong as we thought it was? I mean, I've read a few stories when maybe inflation will never drop below 3%. Fed rates, I wouldn't be surprised if you saw the Fed raise rates rather than cut rates during the course of the year if inflation doesn't come down.

47:42But it tells you how much markets are driven by mood and momentum. And I think this month will be a make or break month because the mood continues to shift down. We'll be heading into the summer in a bad mood with momentum kind of against us and you put on top of it a presidential election and political instability, we could be looking at a pretty bad year by the time we're done. And it's across sectors and there's an adjustment. You're going to see it cut across. So for the moment, that's what I'm keeping my own is that mood and momentum factor. There isn't a sector that I can point to. That sector is obviously undervalued right now.

48:22It's because collectively, I think everything's been pushed up so much that you look at beverages, you look at technology, everything is trading at a much higher multiple of everything than it did a year ago, two years ago. But I think you're just one big correction away from things starting to pop onto your radar saying that's been pushed down too much. I mean, I think the entertainment space is an obvious space where I can't buy Disney because my son works at Disney. So I don't want to create issues with them because that's one reason I don't value Disney or write about Disney, though I have lots of thoughts about Disney because I use it in my class.

49:00But to me, Warner looks interesting because it doesn't have the Sherry Redstone effect that I would get with Paramount. And I think the content, I mean, ultimately, I don't care if you're an entertainment giant. Without the content, what exactly are you going to stream? So I think the content is interesting enough. And ultimately, I think somebody's got to be in charge of the content. And Disney and Warner are still better at creating content than Netflix is. Netflix throws a lot more money, but it creates a lot of crap along the way. So I think that to me, there will be more businesses like that show up on my radar.

49:41Now, I'm interested in PayPal as a company. I'm amazed at how much the mood has shifted against from PayPal being this high-flying financial service company to. It's boring and nothing's happening. I have companies that I have on my list that I haven't bought yet that I want to wait through me and see what happens because I'm just one downturn in the market away from saying, oh, those companies look good. And I would say the same thing to the person who says, can I ever buy NVIDIA? And my reaction is in the last 15 years, NVIDIA has been cheap at least five times on an intrinsic value basis. It's not been an all-upswing.

50:21I mean, the reason I bought NVIDIA in 2018 is people were beating it up, saying this is the end for NVIDIA. There will be a time on every one of these companies where it's the right time to buy. It might not be right now, but patience has its own rewards. Just in terms of asset allocation, I've never owned bonds. And I have a lot of friends who manage credit funds. and they've said to me lately, Scott, why are you in equities? Do you think the markets could be really volatile? Do you think the markets could go down substantially? And the answer is, sure, I can see it. And they said that, look, I can get you with reasonable certainty, 10 to 12 % a year in the credit markets right now.

51:01I can find you high quality debt in great companies and get you double digit returns and nothing's guaranteed. But the number you're getting, the return you're getting on fairly low-risk assets has surged, why wouldn't you reallocate or rethink your portfolio strategy and allocate more to credit? What are your thoughts? In general, you're right. Fixed income clearly is, for a decade, it was equities or nothing, right? You earn nothing on T-bills, nothing on bonds, even AAA-rated bonds, you were earning 2%, 3%. And I think that we have more choices now, and I think we need to look at those choices.

51:40I don't think you can make, to be quite honest, the 10 % to 12 % with no risk comes from the fact that when lenders and bondholders look at risk, it's always backward looking. There's been no default in the last decade. Based on that, it looks pretty safe. But we know that at least in bond markets, default risk is highly correlated, which means that if there's trouble, there's a tipping point where all your bonds get into trouble at the same time because of some macro event. 2008 was a classic event. Bonds that look safe all of a sudden start to blow up on you. But I do think you can make solid returns.

52:16I tiptoe into this because I've not been a big fixed income person. But I'm much more conscious about sweeping my money into tables where I make 5.5 % a year. That's a lot of money to leave on the table if you have it in cash. Would I lock in bonds? The reason I worry about bonds is the same things that would bring equity markets down are the things that will bring bonds down even more. For instance, if you think inflation is your big worry that it might explode, it's going to bring equities down, but it's going to be far worse for bonds because you have no pricing power to increase your coupon.

52:51Your coupon is stuck. So the 10 % to 12 % is assuming that you effectively are going to stay in this debt and that you collect the interest payments with no default. But the price of debt, especially if it's long-term debt, is a function of what's happening to inflation and interest rates. And as we saw in 2022, I mean, stocks were down 20 % because inflation went up, but bonds had a return of minus 22%. It was the worst year for the bond market in a century. Inflation is deadly for stocks, but it's even more deadly for bonds. So it depends on what you think your worry is for markets. My worry more than the economy is inflation.

53:35Because in my experience, inflation is incredibly stubborn. You think you've conquered it, but it finds a way back. And I think, as we've seen in the last three years, you think you've got it nailed, but then it comes back because it seems to seep in through other channels. And if inflation is my worry, I'm just as exposed, perhaps more so if I put my money in long-term fixed income as I am in equities. You also recently wrote this piece on risk in your blog, Musings on Markets, which I thought was great. And you brought up this distinction between incremental risk and catastrophic risk. The former is, you know, risk to sales and earnings.

54:16The latter is, you know, something that can kill a company. I mean, I don't want to waste your time, but I want to give you a little bit of background to how I wrote that paper. It started with an email I got from somebody in Iceland reading, you know, who read my blog. He said, look, you know, I am an appraiser in Iceland. And one of my jobs is to appraise the value of this company or business called Blue Lagoon. Blue Lagoon is this legendary Icelandic spa. And it's been around a long time. It's great margins, great profits, but it's facing an existential threat, which is the volcanoes that have become active in Iceland.

54:54the lava is flowing in the direction of the blue lagoon he said how do i incorporate that risk into my value for the company it's too late to buy insurance obviously because the answer is go buy insurance build in the cost so it started me thinking about how do we deal with catastrophic risk in investing in valuation so i was walking my dog on the beach which is where i do much of my thinking. And I was thinking about this and I said, before I point fingers at other people not dealing with catastrophic risk, I just walked out of my house, which is two blocks from the Pacific Ocean and sits on an earthquake fault.

55:35And I paid two and a half million dollars for this house. Did I bring in catastrophic risk into the valuation of this house? I mean, I'm one tsunami away or one earthquake away from the house becoming rubble. And my earthquake insurance is very limited. It's not going to rebuild the house and a tsunami. I don't even have tsunami insurance. So I don't even know what would happen if that happened. I said, I'm not building it. And I think this is part of a broader theme with catastrophic risk in investing. You know what? We deny it. We act like it's not there. And I think there's a reason for it.

56:10You know, I use this example of an apocalyptic movie, Mad Max Beyond Thunderdome. I said, Go watch the movies, check to see how many times people in that movie check what their portfolio is doing. Nobody does, right? It's survival, survival, survival. So I think in a strange way, as investors, as businesses, we shut off catastrophic risk. We pay$500 million for a building in downtown Manhattan, even if we believe that climate change is going to put Manhattan under water because our view is, what's the point of even bringing it in? At that point, my portfolio won't matter anyway. Life is going to come to a standstill.

56:52I'm either going to live or not live. And I think that's part of a broader issue in business and investing. We tend to ignore catastrophic risk entirely. In fact, I think there might be lessons there for the climate change folks, which is if you preach catastrophe and you ask people to behave better, it's not going to happen. It's like telling people that they have 60 days to live and saying, can you live more healthily? If I have 60 days to live, what difference does it make? So if you want people to behave better, maybe less catastrophe forecasting and more there is hope and you can change things.

57:30But I think it's part of it. I mean, I think we're starting to grapple with the question of catastrophic risk and how to bring it in. But we're just very early in the process, and we're not very good at dealing with it. Aswath Damodaran is a professor of finance at the Stern School of Business. Aswath, as always, we really appreciate your time. Thank you, Scott. This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our associate producers are Jennifer Sanchez and Alison Weiss. Our executive producers are Jason Stavis and Catherine Dillon. Mia Silverio is our research lead.

58:05And Drew Burrows is our technical director. Thank you for listening to Prof G Markets from the Vox Media Podcast Network. Join us on Wednesday for Office Hours. And we'll be back with a fresh take on markets every Monday.

58:30In kind reunion

58:37As the world turns And the dark flies In love Thank you.