The specialty of Aswath Damodaran, professor of finance at the Stern School of Business at NYU, is valuation. He literally wrote “the book” on it –Â or actually several of them. He writes an amazing blog that is widely read by both value investors and other students of the markets. These are three of his investment ideas, which he continues to like and is long –Â as per the end of 2015:
Microsoft
Damodaran said he doesn’t like the company but likes it as an investment. Damodaran valued Microsoft (MSFT, Financial) publicly on his blog for the last time back in 2013, which is still helpful:
I decided to take a shot at valuing Microsoft by breaking it down into the value of assets in place (Microsoft Office and Windows, for the most part) and expected value of growth. In the fiscal year ended June 30, 2013, Microsoft reported $26.76 billion in pretax operating income on revenues of $77.845 billion; revenues increased by 5.60% over the previous year, but operating income was down 4.26%. Using the company's effective tax rate of 19.2% for the year and attaching a cost of capital of 8% to the company (in the 60th percentile of U.S. companies), you can value Microsoft assuming no growth in the future:
Value of assets in place (with no growth, no reinvestment) = $26,764 (1-.192)/ .08 = $270,316 million
Adding their cash balance of $77.02 billion on June 30 to this value and subtracting out the debt outstanding of $15.60 billion yields an estimated value of equity of $331.73 billion, about $61.20 billion higher than the market cap of $270.54 billion. Put briefly, assuming no growth in earnings, Microsoft is worth about 22% more than its market capitalization. You can give the spreadsheet a try, if you are so inclined. (I know that I may be overstating the value of assets in place by assuming that Office and Windows will generate earnings in perpetuity, but using a 15-year annuity yields a value close to the market price.)
Damodaran expects little or negative growth for most of the older and larger tech companies and in his opinion they often appear undervalued on traditional metrics like P/E while not actually being undervalued. This is due to the way their costs are front-loaded early on in their life cycle while they appear overly profitable in the later stages of their life cycles.
One important thing tech companies need to refrain from to stay alive is to continue to make big bets in order to reinvigorate their businesses. This is also often called paying for growth. Executives try to attain growth at all cost but actually destroy value in the process. Damodaran does not agree with every choice by Nadella, but he complimented Nadella in a very peculiar way in a discussion about CEO pay.
While I do not agree with everything that Mr. Nadella has done over the last year at Microsoft, I think that he has done enough for me as a stockholder that I don't begrudge him his $84 million pay package.
Saying a CEO is worth $84 million is a very nice compliment. Especially in the context of the discussion linked to above, Damodaran is not a fan of huge checks going to the CEO. Meanwhile Microsoft sits on about $100 billion of cash, it has debt of only $40 billion. It trades at 16x forward earnings which is roughly in line with the market. If you adjust for its net cash base, it is quite a bit cheaper. The company is a favorite of quite a few gurus as well.
Lukoil
Lukoil (LUKOY, Financial) is a big crude oil and gas producer, vertically integrated to also refine it into petroleum products and petrochemicals. With its 150,000 employees, it’s a leader in the Russian market which is probably why its share price got massacred over the past few years. Russia is deeply out of favor with investors because of its invasion of Crimea, its currency problem, Putin and the lingering fear of communism. It is also an emerging market, and it is heavily dependent on commodities like oil.
Of course, being an oil production company is not a particularly good thing to begin with when people are talking about $30 oil. Damodaran wrote about Lukoil on his blog and provided an in-depth valuation (emphasis mine):
I followed a similar path for Lukoil. In my base case, I left operating income at 20% below the estimated 2014 and valued the firm as a stable growth firm (with a 2% growth rate) and with a cost of capital that reflects an updated equity risk premium for Russia (9.50%). Even if I assume that oil prices drop by another 20% and that the standoff over Ukraine will not end soon (translating into higher equity risk premiums), the value per share that I get is $50.56, higher than the stock price of $45.30.
At $45.30 a share on Nov. 18, 2014, I am again either missing something profound or the stock is massively underpriced. Here again, you can download the spreadsheet and make your own choices
There is a lot of hair on this one, but if you look at the valuation metrics you’ll understand why there may be value there. It trades at an EV/EBITDA of 2.6x at 0.3x book value, and it has $13 billion of debt compared to similar operating cash flows.
Twitter (TWTR, Financial) needs no introduction, of course. In case you missed it previous CEO Dick Costolo is out and Jack Dorsey (founder) is back at the helm, but he runs Square Inc. (SQ, Financial) at the same time.
Damodoran doesn’t believe in the way Twitter is being managed, but he has other critical notes as well. Twitter doesn’t have focus. The company hired a diversity head before it was even making money. It needs to start making money and focus on surviving instead of thinking about the rest of the stuff. Actually, he considers its assets to be badly misused –Â especially its user base, which he values very highly.
To value investors using metrics like number of users and total addressable market, it is a somewhat alien approach, and they often consider these tools of the despised trader. However, Damodoran’s thinking and writing about valuation is very different than most people who throw around metrics like these (emphasis mine):
Twitter’s bigger problem is not being able to convert its existing user base into revenues. There must be a way to monetize a social media presence that causes governments to quake, politicians to fall and breaks news ahead of established news services. My narrative for Twitter, therefore, is very similar to what it was in 2014. I believe that it will eventually get a management team that finds a way to convert potential to profits, stops catering to equity research analysts and expands its international presence. My valuation reflects this narrative and yields a value per share close to $26 per share, and you can download it by clicking here. The simulation delivers the following numbers:
Note that the distribution of values for Twitter is much less symmetric than the distributions for Facebook (FB, Financial) and Apple (AAPL, Financial) and is skewed toward larger values. This is not uncommon for small, high growth companies and is part of the "option" story, where you buy these companies to take advantage of the potential for breakout values. While the stock is, at best, fairly valued (at least based on my value), the optionality tilts the scale for me, and my (limit) buy orders were executed on Friday at $27 per share. I am now a Twitter shareholder, and needless to say I will keep you posted on how this investment evolves.
Twitter is in a net cash position just like many of its tech peers. It trades at high traditional multiples even through it has fallen back quite a bit. Today it trades at approximately 35x forward earnings. However this should be viewed in the context of Damodaran estimating the company’s revenue is severely underoptimized, and its earnings are still burdened with a lot of costs associated with the rampup of a tech business.
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