Book Review #34
During b-school, I did a course called Investing in Private Equity (INPE) taught by Wharton Prof. Vinay Nair and through him heard about Prof. Aswath Damodaran (NYU). I was amazed to know that Aswath (like me from Chennai) was the 'God of Valuation' and I started following his blogs. During covid, I started watching his YouTube valuation videos and occasionally even dreamt of becoming a Private Equity professional turning around companies 😂💡.
'Narrative and Numbers' is Aswath's seminal work on valuation. After sitting on my reading list for 2+ years, I finally read the book and here are my key takeaways from the book.
- We relate to and remember stories better than numbers, but storytelling can easily lead us into fantasyland. Numbers, allow us to be disciplined in our assessments, but without stories behind them, they become weapons of intimidation and bias. Hence, we need both stories and numbers for investing using 'valuation' as the bridge.
- Good storytelling can make a huge difference in the success of a business, especially in early stages. 3P test for stories - is your story possible, is it plausible; and finally, is it probable. Not all stories that are possible are plausible, and among all plausible stories, only a few are probable.
- Early-stage venture capitalists are taking their chances on possibilities, knowing full well that only some of these possibilities will become plausible and fewer still will make it all the way to the probability end of the spectrum.
- Numbers offer a sense of precision and objectivity and provide a counterweight to storytelling. That precision can be illusory as there are many ways in which biases creep into numbers.
- The process of collecting, analyzing, and presenting data all provide opportunities for biases to enter. Biases are hidden far better with numbers than with stories.
- Value and Price are different: The intrinsic value of an is asset based on its fundamentals: cash flows, expected growth, and risk. On the other hand, the price of an asset (or stock) is set by demand/supply, the push and pull of momentums, fads, liquidity and other forces. Investors focus on value whereas Traders focus on price.
- Remember the valuation triangle, the balance between growth, reinvestment, and risk. Marginal Return on Capital = Change in Operating Income / Reinvestment. This ratio helps you measure the quality of a business.
- Narratives can change due to many factors - macroeconomic factors, company lifecycle stage, management changes etc. Even Maynard Keynes said: “When the facts change, I change my mind.”
- Early in a company's life cycle, narrative drives the value. In a mature company, the narratives are secondary, and the numbers come to the fore.
Aswath's objective is to get both poets and quants to read this book, helping poets bring numbers into their storytelling and help quants tell stories to back up their numbers. A heavy read!
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