Monday, January 11, 2021

Professor Damodaran's "Data Update 1 for 2021: A (Data) Look Back at a Most Forgettable Year (2020)!"

He may have the toughest job in finance: trying to apply rational valuation models in a world gone mad.

From Musings on Markets, January 9

I spent the first week of 2021 in the same way that I have spent the first week of every year since 1995, collecting data on publicly traded companies and analyzing how they navigated the cross currents of the prior year, both in operating and market value terms. I knew that this year would be more challenging than most other years, for two reasons. The first was that the shut down of the global economy, initiated by the spreading of COVID early last year, had significant effects on the operations of  companies in different sectors, and across the world. The second was that, starting mid-year in 2020, equity markets and the real economy moved in different directions, with the former rising on the expectations a post-virus future, and the latter languishing, as most of the world continued to operate with significant constraints. In this post, I will start with a rationalization of why I do this data analysis every year, follow up with a description (geographic and sector) of the overall universe of companies that are in my analysis, list out the variables that I estimate and report, and conclude with a short caveat about 2020 data.

Data: A Pragmatist View

We live in the age of data worship, where investors, analysts and businesses all seem to have bought into the idea that big data has answers for every question and that collecting the data (or paying for it) will create positive payoffs. I am a skeptic and I have noted that to make money on big data, two conditions have to be met:

  1. If everyone has it, no one does: I believe that if everyone has a resource or easy access to that resource, it is difficult to make money off that resource. Applying that concept to data, the most valuable data is unique and exclusively available to its owner, and the further away you get from exclusivity, the less valuable data becomes. 
  2. Data is not dollars: Data is valuable only if it can be converted into a product or service, or improvements thereof, allowing a company to capture higher earnings and cash flows from those actions. Data that is interesting but that cannot be easily monetized through products or services is not as valuable.
All of the data that I use in my data analysis is in the public domain, and while I am lucky enough to have access to large (and expensive) databases like Bloomberg and S&P, there are tens of thousands of investors who have similar access. Put simply, I possess no exclusivity here, and staying consistent with my thesis, I don't expect to expect to make money by investing based upon this data. So, why bother? I believe that there are four purposes that are served:
  1. Gain perspective: One of the challenges of being a business or an investor is developing and maintaining perspective, i.e., a big picture view of what comprises normal, high or low. Consider, for instance, an investor who picks stocks based upon price to book ratios, who finds a stock trading at a price to book ratio of 1.5. To make a judgment on whether that stock is cheap or expensive, she would need to know what the distribution of price to book ratios is for companies in the sector that the company operates in, and perhaps in the market in which it is traded. 
  2. Clear tunnel vision: Investors are creatures of habit, staying in their preferred markets, and often within those markets, in their favored sectors. Equity research analysts are even more focused on handfuls of companies in their assigned industries. So what? By focusing so much attention on a small subset of companies, you risk developing tunnel vision, especially when doing peer group comparisons. Thus, an analyst who follows young technology companies may decide that paying ten times revenues for a company is a bargain, if all of the companies that he tracks trade at multiples greater than ten times revenues. Nothing is lost, and a great deal is gained, by stepping back from your corner of the market and looking at how stocks are priced across industries and markets....