NYU finance professor explains why the stock market is more 'Game of Thrones' than 'Snow White'

NYU finance professor Aswath Damodaran is a number-cruncher.

But in his new book, “Narrative and Numbers: The Value of Stories in Business,” Damodaran concedes that the numbers aren’t the only thing worth poring over when valuing a company.

Ultimately, humans respond to, and seek out, stories. And all businesses have one.

“This book is as much about my journey from just trusting the numbers to understanding that numbers alone can never make a valuation of an investment,” Damodaran told Yahoo Finance in an interview.

“I think we have our own delusions,” Damodaran added. “Number crunchers’ delusions are that numbers are precise. The way I describe this is the reaction the number cruncher has to uncertainty is to add decimals… But the reality is if you work with numbers long enough you learn that you can hide some big biases behind simple numbers.”

Below are some of the key quotes, lightly edited, from our wide-ranging discussion with Damodaran about the the stock market, Uber, investment banking, and more.

On how the stock market’s story differs from company-specific stories:

“The market does tell a story but it’s more of a Game of Thrones story than Snow White. So you have no idea, there’s stories unfolding all over, each pulling you in a different direction. It’s not a simple story to untangle.

“So to me Dow 20,000 was just another number. I know that there’s a lot of celebration, 10,000, 20,000, we can all say I was there when the Dow crossed 20,000. Who knows when we’ll cross 30,000. But I think that there is a story that’s playing out in the market now about change that’s coming and at least, on balance, the market seems to be okay with the change.

“The one thing I would ask people to think about, when they listen to experts talk about the market, is these are the same experts who before Brexit passed told us that if Brexit passes, the market’s going to collapse. Before the presidential election, they said if Donald Trump wins the market’s going collapse.

“Now of course their stories have been reframed. It’s almost like they have the amnesia to forget everything they’ve told us before. And they’re now spinning this really neat story about this is good for the market or how this is bad for the market. If there’s one less we learned out of 2016 it is please don’t listen to the experts. And if you count me as an expert, please don’t listen to me.”

On Uber’s valuation and the challenges it faces:

“First, we have to recognize that when VCs attach numbers to companies they don’t value them, they price them. That sounds like a distinction that doesn’t make sense, but it’s a distinction I draw. When you price something, you price it based on what other people are paying for similar companies, similar investments. And right now ride-sharing, on-demand companies are hot. They price relative to each other. That doesn’t mean $68 billion is an unreasonable value, because one of the things about even attaching a story and a number to a young company is the potential narratives are much, much wider… All I draw from my valuations is based on my story for Uber, I wouldn’t invest in Uber. It’s not my job to tell other people they are paying too much at $60, or $65, or $68 billion. Just make sure you have a story that justifies your investment. […]

“I think Uber actually is not going to have trouble on the revenue side. I think they are actually going to deliver revenues at a rate that you expect them to. I think the bigger problem is making money off those revenues. They have a business model that I think is right now inherently indefensible. It’s indefensible because what allowed them to grow so fast is making it difficult for them to defend their revenues and make money off it. So I think that’s going to be Ubers big challenge, is how do you convert this revenue-making machine they’ve become into a profit-making machine.”

On changes in the tax code:

“The tax code is a bludgeon. When you change the tax code trying to make companies do the right thing, you almost always have a law of unintended consequences.

“So let’s say you change the tax code to encourage companies to invest in the US rather than outside the country. That sounds like a good thing. So you pass the law, it goes into the code, and then all of a sudden you discover that companies are misusing it to actually save taxes without actually increasing investment in the US. And people throw up their hands. That doesn’t surprise me. Tax codes have never been effective behavior modifiers. If you want companies to invest more in the US, you have to make it in their economic best interest, their operating best interest to bring business back to the US.”

On how stories warp valuations:

“I think you see stories, especially when you listen to founder talk about businesses or analysts talk about businesses, and it’s all about the story all the time. And what you’ll often find in these stories are what I call weapons of mass distraction. There are words you throw in because they dazzle people. Words like, ‘disruption,’ ‘strategic,’ ‘synergy.’ … These are the words we use because the numbers don’t fly.”

On the benefits, and pitfalls, of discounted cash flow models:

“If you talk about [discounted cash flow] from a banking perspective, the way bankers do it I’d much rather they not even try. I’d prefer they actually do a simple pricing, use EV/EBITDA multiples and move on. Because the way it’s practiced in banking, I don’t even think it is a discounted cash flow valuation. It’s just a bunch of numbers in a spreadsheet that you move around to get a conclusion you wanted to see in the first place.

“I think if you think about what a discounted cash flow valuation is telling you about a business, it’s saying the value of a business is a function of its expected cash flows, the growth in those cash flows, and the risk in those cash flows. If you don’t think of it as an equation but you think about those three very simple concepts, as long as people have been buying and selling, those fundamentals have driven value.

“To me, a good discounted cash flow model is if I point to a number and say why is that number what it is, I want to hear a story, not a bunch of other numbers to back up that number.”

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Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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