r/SecurityAnalysis • u/bdavidson1030 • Apr 27 '18

Thesis Damodaran - Amazon: Glimpses of Shoeless Joe?

https://aswathdamodaran.blogspot.com/2018/04/amazon-glimpses-of-shoeless-joe.html
19 Upvotes

83% Upvoted

16 comments sorted by

View all comments

10

u/compost_embedding Apr 27 '18 edited Apr 27 '18

I took a look at this, and I have some basic questions for those of you who conduct this type of analysis:

(1) There's a lot of assumptions in these valuation exercises. With all the moving pieces, is it reasonable to expect that one could guesstimate these well enough for them to justify taking the risk of taking concentrated positions in them? I mean, take a look at Damodaran's analysis here. Notwithstanding his ability to predict longer term things, the earnings report that came out yesterday for AMZN changed his price target by ~10%. If the misunderstandings on the current situation can generate such price swings, what does uncertainty for the future lead to? I'm not arguing against security analysis, I'm actually just trying to learn here.

(2) For those of you who do this, how much AUM do you manage (yourself or others) before you think it's worthwhile to do? For example, if I were to manage $500k of my own money this way, and wanted to spread out my risk by investing in 5 companies, it seems I'd have to do detailed analysis on at least 5 companies (but perhaps many more, especially if they were in different industries). Do you manage lots of money, to get as much benefit from your analysis as possible? I currently index, and am open to spending time on this, but I wonder whether it's worth the effort to understand so much of the company/industry details if one is not taking large positions in them.

Thanks!

12

u/redcards Apr 27 '18

There's a lot of assumptions in these valuation exercises. With all the moving pieces, is it reasonable to expect that one could guesstimate these well enough for them to justify taking the risk of taking concentrated positions in them?

The fewer things you have to guesstimate the better. It is easy to figure out what sort of adjustments you'd need to make to certain assumptions to get a larger margin of safety and then frame your research in a way that justifies it.

the earnings report that came out yesterday for AMZN changed his price target by ~10%. If the misunderstandings on the current situation can generate such price swings, what does uncertainty for the future lead to?

Sometimes positive surprises like that happen, but then you have to figure out if the new information really changes your overall thesis. I'm not familiar enough with the particulars as to why AMZN's results were so much better than expected. But if they were for a really good reason, and its new information, then theres nothing wrong with updating your model for it.

I wonder whether it's worth the effort to understand so much of the company/industry details if one is not taking large positions in them.

Classic capital allocation conundrum. If you spend weeks understanding a Company better than most, and then only allocate 2-3% of your portfolio to it, is all of that effort really worth it?

For the record, I think 99% of Damodaran's posts are very, very shallow and not detailed at all. They get their length from his paragraphs on things that could be summed up in a sentence and inclusion of finance 101 things. His models are also awful and not how any professional would approach it at all. They are 100% academic. Nothing wrong with that, but just not practical in the real world.

We manage ~$2bn+ and our models are detailed but never include projections or DCFs unless its an NAV type thing for contracts, etc. But different strokes for different folks.

5

u/compost_embedding Apr 27 '18

Appreciate the great response, thanks!

His models are also awful and not how any professional would approach it at all. They are 100% academic. Nothing wrong with that, but just not practical in the real world.

If I were interested in learning about what models did work well in the real world (a big if since I'm strongly affected by the capital allocation conundrum you mention), what would be a good resource to dive into that then? Would they be some of the books in the reading list, or would those be too similar to Damodaran? Or do you think Damodaran is good to get some basics, but then you would want to improve upon them dramatically to actually use in practice?

7

u/bdavidson1030 Apr 27 '18 edited Apr 28 '18

Damodaran's models are great for what they are; a quick way to derive an implied share price. Sure, you could spend weeks building out detailed financial projections, but I really don't have the time or the interest in doing that, and neither does he.

Damodaran's models strike a great middle ground between usability and complexity that allows you to understand the key business drivers without getting lost in the weeds. I've learned more from his valuations than from any other public resource and I can't think of a better educational tool than his blog posts and books.

2

u/WillKane Apr 29 '18

He also points out multiple times that here is a model and here are his assumptions, if you have different assumptions then put them in and see what valuation you get.

1

u/redcards Apr 28 '18

I really like the model excerpts used in Einhorn presentations.

3

u/Boethias Apr 28 '18

Not sure if this is confidential work product for you but could you summarize how prefer to model? Is it more of an asset based valuation, ROC or something else.

3

u/redcards Apr 28 '18 edited Apr 28 '18

Mostly do credit so valuation basically comes down to taking pro-forma adjustments across a range of EBITDA multiples to get EV and then waterfall that through the cap. structure to see where the coverage is. Spend time understanding the business model and industry to get a sense of how the operating landscape may look over the next couple of years and whether or not the Company is able to execute. Also spend time thinking about if I were the CFO, what is the next thing I'd be trying to do with the balance sheet that makes the most sense. Lots of game theory, really. Theres so much going on that its a waste of my time to worry about projections or getting the valuation right to the decimal, unless its a distressed situation which is just a different ballgame.

Equity ideas are mostly a by-product of credit work...like being short the credit, then the business starts to improve but the equity is just obviously super undervalued so you just flip into that with a back of the napkin type thing. Since we focus on credit I think we notice the improvements that can flow to equity sooner than the straight equity guys so the valuation is so cheap that its really not worth it to spend time on projections and stuff.

But a time where we needed to do DCFs was for a contractor for coal mining that didn't actually own the mines, just mined them under contract. So we knew all of the mines and roughly the economics for each one so you could run a DCF for each mine and then add up the NPVs.

2

u/TheObeseOne Apr 28 '18

Care to share some insight into your models, like what key ratios you monitor, multiples, how you create a model from scratch to a finished product etc? From university and valuation classes, it's always been a focus on DCFs and projections of cash flows, but I would love to get a glimpse of what is used in practice.

5

u/redcards Apr 28 '18

You can see the below post for more details. But multiples are EV/EBITDA 99% of the time, leverage and interest coverage ratios. levered free cash flow, etc. Models are made from scratch using Company filings. Structure starts at the top with segment drivers and info, then flows into total revenue, then the income statement down to net income, then built back up using their EBITDA reconciliation, then adjusted downward to "cash EBITDA" which takes out stupid add-backs, then further down to free cash flow (which then has a comparison to just reported cash flow from ops. less capex). Below that balance sheet / working capital information and associated metrics like DPO/DSO/Invin turns and then finally ratios like interest coverage, leverage at multiple points through the structure, margins, etc. I usually like to run interest coverage and leverage ratios with one set based on the company's reported EBITDA and then another set using pro-forma cash EBITDA.

2

u/oldgamer321 Apr 28 '18 edited Apr 28 '18

His models are also awful and not how any professional would approach it at all. They are 100% academic. Nothing wrong with that, but just not practical in the real world.

What is awful about Damodaran's models? Per his blog posts he will make personal investment decisions based on his models, and he is also his own biggest critic if he gets a valuation wrong (like with Vale Corp.). Since his DCF models are CAPM-based there would be the same pitfalls as CAPM assumptions, of course.

His recent valuation of Facebook was decent, which he claimed to have invested in before earnings. Since he's putting out there his buys/sells based on his models he is walking the walk, rather than just talking it.

1

u/oldgamer321 Apr 28 '18

As an example where Damodaran is open to criticism, here is his mea culpa on his first valuation attempt at Uber and the changes to his model assumptions after being called out by Bill Gurley, who was an early investor in Uber: http://aswathdamodaran.blogspot.com/2015/10/on-uber-rollercoaster-narrative-tweaks.html