Prof G Markets: Third Quarter Review — with Aswath Damodaran

24:34If, in fact, these drugs are going to make America less heavier, isn't there just an entire cadre of entire sectors that are going to register enormous value destruction? Less heavy and less hungry. The hungry part is what affects them. It's not the less heavy part because if they had to eat light food and, you know, that's how you lost weight, it'd be very different. And the only company right now that has benefited from these drugs is Novo Nordisk because it reduces the drugs. Everybody else, you're looking and say, what will the effect be? Now, I think glory days for all of these companies were behind them anyway.

25:10whether you're looking at the fast food companies or the processed food companies, it's true they've gone up five, six, tenfold over the last 40 years. But over the last decade, they've been very average investments. So I think that if these drugs are going to have an effect on their business, it'll be small and it'll be over time. But we'll notice them eating away at their revenues and profits. They have the benefit of large portions of the world that are still underweight that they can work on to make obese, I guess. So that's our hope. There are 2 billion people, 3 billion people in Asia that we can work on.

25:50It's a terrible characterization of a growth plan. But fast food has a way to go still if you think about Asia and Latin America as potential markets. And my fear is that you're going to see the obesity epidemic that has kind of gripped the U.S. kind of spread into the rest of the world as well, if it hasn't already. So last week on your blog, Musings on Markets, you published your Tesla valuation. You landed at$180 per share, which is 15 % below its current trading price of$213. and I have to admit I would have expected a lower valuation from you considering the extent to which narrative plays a part in the market's valuation of this company.

26:32I mean you know narratives about software and about robots and Elon's overall vision and genius but in this valuation you actually applied numbers to those narratives and you said that the software business which is nascent at best is worth$50 billion. And you said that the robotaxi business, which doesn't exist at all right now, is worth$120 billion. Could you take us through your thinking here? I think that the fact that something is nascent doesn't mean it doesn't have value. I mean, let's face our cars are increasingly computers and software runs them. So we know auto software is going to be a growth business.

27:14Part of it is going to be AI. Part of it is going to be FSD, part of it is going to be something else. And much as people like to take Tesla's FSD efforts apart, and I think that they're often rushed to the market, they're overhyped, the reality is it's the only automobile company that seems to be taking FSD seriously as a business model. So much as we'd like to say, this isn't ready, and in fact, I don't start the revenues from robotaxis to 2027, because I think it'll take a while for them to work their way through the technological barriers and the regulatory barriers. But I think that the connecting narrative numbers is always something I've emphasized.

27:54I've said, look, I'm willing to listen to your story, but I want to make sure that the story doesn't become a fairy tale. Maybe I'm pushing the limits of these narratives with the numbers I'm attaching to them. But I think these businesses are going to shop. It's not a question of whether there will be a robotaxi business or whether there will be an auto software business, the question is who's going to be lead players in the business? I think Tesla is going to be one of those lead players. Now, but if I value Tesla just as an automobile company, my value per share is 120. So when people often say, look, this looks high, it's because those side businesses are where the value comes from.

28:33I'll tell you the one thing that Tesla is doing that makes me believe that they believe the side businesses are where the money is going to be made is the price cuts, which is that they're cutting prices on cars, effectively lowering the margins in the hope. The hope might be misplaced that selling more cars is going to allow them to do other stuff. And what I'm trying to do is bring that other stuff into the equation. I mean, the 180 is with every lever in full throttle. And if it's at 200, even with every lever in full throttle, is saying, what do I do next? In fact, I've already got pushback from Tesla Optimus saying, where's the bot business, the Optimus business?

29:16I mean, it's amazing. Each time you hit a business that Tesla's in, they come up with three other businesses. Two out of the three will never make it out. I don't think the insurance business is a good business for anybody to be in, least of all Tesla. And I actually, in my corporate finance class last semester, pulled all the numbers I could about Tesla bots and said, value Tesla bots alone as a project. And I got values in the billions, maybe a few tens of billions, not hundreds of billions. So if it's a business, I don't see it as the kind of trillion dollar business that people are making it out to be.

29:51It's a B2B business. You're selling these robots to other companies that are manufacturing companies, mining companies as replacements of their workers. An entire social cost we're not talking about here. What happens to all those workers, assuming these bots actually make it, that we displace? But that's a mistake we've made over and over again in the last 40 years. We talk about progress as an unmitigated plus, and we don't talk about the costs we create as side costs for everybody else. Yeah. I mean, it feels like the ultimate question with Tesla, right? It's like, which business narratives do you choose to believe?

30:28And I guess my follow-up question would be like, why do you eliminate, what's your line in terms of eliminating the bots business? You're down to value the robotaxi business. I'm not sure if that's a new decision this quarter, but where do you draw that line on what counts and what doesn't? I have a divide which I use in valuation of possibilities, plausibilities, and probability. it. Possibilities are options. It could happen, but you don't have enough substance around it to put numbers on it. Now, until about two years ago, the robot taxi for me was a possibility. It was an option. I was willing to listen, but I said, look, I can't put any numbers because you're not far enough along the way.

31:11This year in particular, I'm willing to open the door that these businesses are starting to become plausible. That's a judgment call. Will that happen with the robot business? I'm not sure. Now, it might just fade away because there are other businesses that Tesla's claimed it will enter that really never materialized. So you start with the possibilities, you view them as options. If they play out, then you convert them into plausible scenarios, bring them into the numbers. And the end game is ultimately they start to show up in your financials as actual revenues, actual operating income, actual cash flows.

31:45So let's talk about the other auto guys and the energy companies. It appears they got out too far over their skis. They're scaling back their kind of EV ambitions. When I look at their valuations, they just look cheap. And granted, they're auto companies and they're not very sexy and they're not Tesla, I should say. And then I look at the energy guys, the Chevrons and Exons in the world, and the fact that, okay, EVs are now up to 2 % of the world's automobiles. And if you assume the world's going to keep growing, it's going to need fossil fuels. Are automobile companies and energy companies on a risk-adjusted basis a good buy?

32:17The energy companies might be. The automobile companies, I'm not sure the legacy automakers have an endgame here that I am comfortable with. So we talk about stories. I'm not sure that I can tell you an upbeat story about any of these legacy automobile companies. Maybe BMW, maybe Daimler, but every other automobile company I look at, and I can't think of a good ending to this story. You know, you're paying 20. I mean, you've already gone through a strike. You've agreed to pay 25 % more for, you know, I think it's an increase of 25%, which the workers might deserve. But at the same time, these companies are not exactly healthy, flush with cash companies.

32:57So I think that they're going to be playing defense. And when all you're doing is playing defense in any sport, it doesn't end well. So I think their scaling back of EV suggests to me that they're conceding that this EV business is not as easy as you might have imagined by looking at what Tesla was managing to do. So nothing that's happened this year makes me more upbeat about these companies. And every time I read a news story, I actually get less upbeat about these companies. On fossil fuels, the difference is unlike Tesla and the automobile business, we've seen a real change in the economics on the ground.

33:39Alternative energies, in spite of all of the money we've poured into, you know, different kinds of alternative energy, trillions of dollars, has barely made a dent in how much of our energy comes from non-fossil fuels. I mean, I just did a piece on impact investing where I looked at the percentage of energy we got from fossil fuels in 1971, 1991, and 2021. Between 1971 and 91, the dependence on fossil fuels dropped by about 5%, from 82 % to 77%. All of it came from the growth of nuclear energy. Between 1991 and 2021, the percentage of energy we get from fossil fuels has remained unchanged. There's been a small gain in solar and wind, wind in particular, but it's come at the expense of nuclear energy.

34:28It's almost like they're cannibalizing each other and you're still dependent on oil, gas and coal for your energy. So I think it's, you know, it's part of the reason I think we need to rethink how we approach climate change. The reason I think impact investing, the only thing it's impacting are your returns and how much money goes into these businesses. It doesn't seem to be impacting the output that we're getting, the changes that we claim we wanted to make because of this investment. We'll be right back. Thank you.

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37:08We're back with ProfG Markets. So if you think about search, I think the genius of search is that it's so ubiquitous and so accessible that they democratized it, and it didn't end up really creating strategic advantage for everyone. Everyone had to use it, and it became a tax that everyone paid to one company. So it increased the stakeholder value of one company and kind of lowered the costs and the profits of everybody else is the thesis I would put forward. Is the same thing going to happen with AI where there's a small number of extraordinary winners and everybody else just has, you know, more efficient but lower profits?

37:39I think that's a safe assumption to make because that's the way every one of these big tech, you know, revolutions seem to have paid out over the last 40 years. PCs, the internet, social media, every one of these, at the end of the process, you look back and say, let's count the winners and the losers. For the bulk of the companies, 90 % plus of the companies, it becomes an additional cost. It's something they have to pay for because everybody else is doing it. And none of them benefit because if everybody has it, nobody has it. It's not like you're the only one using AI. It's like the SAT, right?

38:1630, 40 years ago, my wife tells, I didn't take the SAT, but my wife did in 1981. And she said she just walked in and took the SAT. There were no prep courses, nothing. 40 years later, we've got this elaborate system of SAT prep, but everybody goes through it. And in the end, there's no gain because if everybody has it, nobody has it. My guess with AI is it's going to become this ubiquitous part of every company's toolkit, they're going to be paying vendors and software makers, and they're going to benefit. But the bulk of companies, I don't see the net economic gain from AI changing the way you do business.

38:56Something a bit more serious. What, if any, impact do you think the war in the Middle East is going to have on markets or specific sectors? Have you found any specific companies you think is going to be especially good or bad for them? The last three years have been good for weapons manufacturers, right? No matter how you dress this up, all of a sudden they're back. Outside of that, this war, the direct effects, I mean, I think potentially will be on oil prices and companies depend on oil will see the effects. We haven't really seen a surge in oil prices yet, but that could be the one item that I would keep my eye on is how will this play out in terms of, you know, how OPEC behaves going forward, what will happen to oil prices going forward.

39:40But for the moment, it's had a surprisingly small impact on markets. Now, maybe it should be larger, but it's almost like people are not building in expectations of this expanding out from where it is today. Yeah, just to touch on that, I feel like this wouldn't be a quarterly review if we didn't talk a little bit about macro data. So just a few interesting things this quarter. GDP growth hit 5%, fast expansion in two years. Interest rates remain steady. Fed hasn't raised them since July. And then we've seen some more focus on fiscal policy. The deficit expanded to$4.5 trillion. The Treasury recently said that they were going to borrow nearly$800 billion this quarter.

40:20That's the most the U.S. has ever borrowed in Q4. How have those developments and just macroeconomics as a whole, how have they changed your approach to valuation, if at all? You know, I think that you said rates haven't changed because the Fed hasn't changed rates. The reality is rates are changing. They are markets at rates, and markets at rates are going up. T-bill rates are up. T-bond rates are up. Those are the rates that matter. Who cares what the Fed funds rate is? And I think the FOMC might be watched by everybody, but the reality is rates have risen. And the question is, what's the message in those higher rates?

40:57What I'm getting as a message out of this is markets collectively seem to believe that we will continue without a recession, but with inflation, that this is here to stay. This notion that if the Fed decides rates can come down to 2%, I think is misplaced. I don't think we're going to go back to low rates. What I do think we have right now is an economy that hasn't adjusted psychologically and economically to those higher rates. I mean, let's take the simplest example, 8 % mortgage rates, right? You'd expect with 8 % mortgage rates that housing prices would drop off. But you're not seeing that.

41:37You're seeing fewer houses hit the market, housing prices staying intact, and homeowners almost saying this too shall pass. But what if it doesn't? You can't sit on your house for the next 10 years. Your mortgages are eventually going. If they're 3 % mortgage, it's eventually left to get paid. There's an adjustment we have made to the higher rates. This is separate from a recession or what I think about the economy. Companies, homeowners, individuals, consumers haven't adjusted to a world where rates are not just high for the moment, they might stay high for the long term. That we're closer to where we were pre-2008 when we embarked on this lower rates, lower inflation scenario that played out for more than a decade.

42:23And I think as companies adjust, you're going to see some pain along the way. It might not show up at a macro level, but it's going to show up at a micro level. Are you, in your valuations, taking those adjustments into account? And if so, how? How do you take those adjustments into account? If you leave the T-bond rate at 5%, you're effectively saying inflation is going to be 3.5 % for the long term, right? Sometimes we make implicit assumptions. In fact, let me take the sometimes out. We often make implicit assumptions. When I leave the rates at 5%, I'm saying, look, for better or worse, if I decided in my valuation to lower the rates to 2 % 10 years from now, I'm effectively saying that this is temporary and it'll pass.

43:05I'm not doing that. I'm just leaving the rates where they are because I think the market, in its collective judgment at least, believes that higher inflation and higher rates are here to stay. And I'm not going to fight that. Why not fight that? Because that's just out of your station? No, it's because it's an opportunity cost. What's the point of fighting If I don't invest in Birkenstock or I don't invest in Tesla, I can't make up a rate of 2 % investment. I'm going to invest in what I have available. And right now, I can lock in almost a 5 % return for the next 30 years. This is not an abstraction.

43:40It's not an estimation. And everything I look at has to beat that 5 % a year for the next 30 years. Aswath, you've always said, I think, trying to make people feel better when they think they've missed the run up in NVIDIA, that there's always an opportunity to buy great companies. At some point, almost every great company, for whatever reason, gets inexpensive. It strikes me that there's been a transfer of value from Alphabet to OpenAI and to Microsoft as Alphabet has been perceived as flat-footed. So one, what companies do you think there's opportunity? And two, do you think Alphabet would fall under that theme?

44:19I think Alphabet actually, outside of the search box, it has amazed me how inept the company has been about all of its other stuff. I mean, I remember when they renamed themselves Alphabet saying, look, you know, we're a multi-business company. That was what, 2015, 16? Seven years later, you look at where the revenues come from. It still comes from the search box. It's like Snow White and the Seven Dwarfs, right? Seven small businesses you can't even find in the financials. And so there's something in the company, I think, that gets in the way of them taking what they've built. I mean, because I'm sure they have great ideas in the company, smart people.

44:57But there's a big question, and I think it's a question worth examining. What is it about Alphabet that makes it so difficult for the company to take advantage of all of these other smaller, promising businesses that have built up but never seem to get bigger. I call it the sugar daddy effect, which is if you're a startup, one reason you succeed is desperation. You know that if you don't pull it off, you're not going to make it through the next quarter, the next year. I don't think any of Google's businesses, and I'd include AI as one of its businesses, has enough desperation in its DNA because they've all been trained to expect a sugar daddy treatment, a billion dollars a year, another two billion, three billion.

45:41Maybe that's getting in the way of development. So maybe they need to kind of restructure in a way that makes their AI business a little more desperate about the future, makes it more urgent for them to develop. Because I think part of what the market's punishing them for is a lack of urgency. But among the big tech, it is perhaps the most reasonably priced one because the market seems to be pricing it still as a search engine that'll never figure out a way to make money on these other businesses. And that could be fixed. And if it's fixed, I think there's a potential for upside. Do you see any other great companies that you believe are on sale?

46:20I'd say consumer discretionary. Look at companies outside of the automobile space, which I think are, you know, because they've not done as well as the rest of the market. So, you know, stay with the big companies, because I think this phenomenon of big over small is not going to go away. So even in those sectors which have done badly, I would look at the bigger companies and look at the companies that are flat this year. In fact, five of the 11 S &P 500 sectors are down this year. This is a market that's been unbalanced, and this was a month ago before you had a further drop in the market. So I would say that look in those sectors for your potential benefits.

47:07Speaking of consumer discretionary, we've been discussing the Birkenstock IPO on this program, and you did a valuation. I think you valued the company around 10 % lower than its issue price, and it's trading around there. But I thought the most interesting insight that you had on Birkenstock was this idea of valuing the intangible assets. Could you give us the the breakdown on your thoughts on intangibles and how to value them? About 30 years ago, an accountant started obsessing about intangibles. And you can see why, right? Because their balance sheets are built around things you can see. My reaction is, leave it alone.

47:45Because to value intangibles, you can't look at the balance sheet. You've got to look at earnings power. You've got to look at earnings and cash flows. And if you do an intrinsic valuation, you're factoring earnings and cash flows, the intangibles are already in there. So when you value Coca-Cola, the intangibles already show up as higher margins and higher return on capital and a higher growth rate for much of the last 50 years. But accountants say, well, I don't believe you. That's a reaction they get. I don't believe you. We have to value intangibles separately. So I use Birkenstock because it's a perfect case study of a company where intangibles drive the bulk of its value.

48:21Because if you strip it down to product, It's a sandal that's either the ugliest sandal ever made or the most comfortable sandal ever made, depending on who's wearing it. But it's a company that's built on a brand name that's tough to replicate. I mean, because it has history going for it, right? The hippies, you've got Kate Moss in, I think, 1990 wearing it on a cover. Basically, it's got 50 years of history driving it. So there's brand name, there's a change in management. If somebody asks, can management make a difference, Birkenstock would be a perfect example, a family-run company that in 2011 and 12 transferred that management to an outsider who happens to have taken all the right decisions, at least for the last decade.

49:08And, of course, this summer, you had the Barbie movie and Barbie wearing pink Birkenstock, another intangible because it pushed up search for Birkenstock, sales for Birkenstock. So what I did was I took the intrinsic valuation. I'd value the company as a whole first. Then I said, let me just break out how much of this value comes from brand name, how much from great management, how much from the Barbie buys. And it's not because I want to put them on the balance sheet. I couldn't care less what's on the balance sheet. It's to show that if you do a good intrinsic valuation, all the intangibles should be in there.

49:42In fact, we talked about Tesla. Lots of intangibles we can talk about, but the biggest intangible is a man, right? Elon Musk. And that intangible brings good things and bad things to Tesla, depending on the day. And the question is, does that intangible make Tesla a more valuable company or a less valuable company? And this is where I think the great divide on Tesla comes about, right? So I think that the Birkenstock example was just my entree to saying, let's talk about intangibles in a sensible way by looking at what it contributes to the bottom line. Because many companies that claim to talk about intangibles, those intangibles don't show up in value.

50:23Where do you land on the, does the manager of Tesla provide negative or positive shareholder value? Net positive, but less so than five years ago, perhaps. And I think in a sense, you know, it's, you know, the mix of effects he brings in now, or perhaps there's a lot more negative now than it used to be. But still, I think it's a net positive. I don't see Tesla valued at the same amount with somebody else in charge, partly because he's never allowed anybody else in the company to get a high enough profile. If he picked another CEO, it'd be somebody you've never heard of. And you're going to turn over a$600 billion company to somebody you've never heard of?

51:05Now, that's going to be the tough transition. And I'm not sure he has a board of directors that's prodding him to think about, hey, who'd run this company if you're not around? He just ruined the word intangible for me. Aswath Damodaran is the Kirshner Family Chair in Finance Education and Professor of Finance at NYU Stern School of Business, where he teaches corporate finance and valuation. He joins us from his home in San Diego. Aswath, as always, we really appreciate your time. Thank you, Scott.

51:41Okay, let's take a look at the week ahead. We've got earnings from Uber, Lyft, Disney, and Warner Brothers Discovery. Do you have any predictions for us, Scott? My prediction, again, I'm GLP-1 fanatic here. This is not only an appetite suppressant, it's a craving suppressant. And I wonder, I think my prediction is, Ed, we're going to start to see stories, I believe, that show that the most religious, avid, obsessed users of social media consume less social media when they're on these drugs. And I wonder what, if any, impact that might have on social media. I don't know if it's the 20-80 rule, but I would be shocked, especially on Twitter, if we didn't find that people like me who are addicted to it, that a small percentage of us, something like the median number of tweets is zero.

52:31The vast majority of Twitter accounts don't post. But there's a small minority of people. I bet, I don't know if it's 1080 or 2080. And I wonder if people like me, who it was getting in the way of other parts of their lives, are at some point going to find that if they're on these GLP-1 drugs, they're no longer crave the dopahit they get from how many likes did I get? Or can I see, you know, whoever it is, Emily Ratajkowski, talking about social justice and she forgot to put on her bra. Is that wrong? Is that wrong, Ed? Anyways, so I think that the blast zone around GLP One's impact on companies that are largely based on your addictions and your cravings, I wonder if the blast zone is going to get broad enough to start impacting stocks in the social media space.

53:21This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our executive producers are Jason Stabbers and Catherine Dillon. Mia Silverio is our research lead and Drew Burrows is our technical director. Thank you for listening to Prop 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.

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