When facts change, I change my mind: Aswath Damodaran on Zomato valuation

Mumbai: Known as the ‘Dean of Valuation’, Aswath Damodaran, professor of finance at the Stern School of Business at New York University, is out with a new book, The Corporate Life Cycle.

Companies have a life cycle very much like humans—they are born, witness growth spurts, mature and then inevitably decline. And just like some of us, they try to fight ageing. Companies employ a host of techniques like acquisitions and hiring expensive consultants in an effort to reincarnate themselves. However, Damodaran argues that all these endeavours inescapably come to naught. A company like Apple or Microsoft being able to turn around its fortunes is very much the exception which proves the rule.

Understanding the corporate life cycle and where every company fits in the framework is crucial for everyone in the chain, from managers to investors.

In a wide-ranging interview with Mint, Damodaran talked about assessing family-run businesses, the current dynamics of the Indian stock market, and how investors can optimize their portfolios through the corporate life cycle architecture.

He also revisited his assessment of Zomato, which he valued at ₹42 a share at the time of its listing and which has soared to more than ₹250 now. “When facts change, I change my mind,” he said, quoting John Maynard Keynes.

Edited excerpts of the interview:

Your new book delves into the life cycle of companies. Is this similar to the life cycle of individuals and even civilizations?

Companies are organisms run by individuals. So like individuals, companies age and also they fight ageing. They want to be young again. They do acquisitions, they get consultants. Basically, it’s human nature, and you see it playing out in companies. And just like it’s pointless for individuals to fight ageing, companies also come around to that, but they spend a lot of money trying to be young again.

But there’s a difference between human life cycles and corporate life cycles. Human life cycles are defined in chronological time. 70,75, 80 years or so. But that may not be the case for companies.

I was in Tirupati for a wedding, and a person came up to me and said we’ve been operating a business that works with the temple and they’ve been around for 750 years! He said 40 generations of the family have been involved in that particular business. And the reason they’ve been able to survive is they picked a niche where they were special and they stayed small. They were not ambitious. The oldest company in the world is Kongo Gumi, a Japanese shrine maker founded in 578 AD.

At the same time, you look at a company like Intel. Founded in 1968, it is now struggling with old age. Or take Yahoo. Founded in 1992, it was done by 2015. So corporate ageing can have a very wide range.

Are fast growing companies at risk of accelerated demise as well?

Eventually all companies age, but whether it’s going to be 20 years or 40 years or 50 years is going to depend on a lot of factors. If you’re a manufacturing company, for example, it might take you 50 years to get big. Now look at how quickly Zomato has gone from nothing to what it is. But there’s a catch. The kinds of businesses where you can grow fast are also the kinds of businesses where it’s tough to hold on and stay at the top for a long time, because the same things that allow you to climb the mountain quickly, allow others to climb up the mountain to get to you.

You also talk about companies which have successfully fought ageing. Are they exceptions to the rule?

There are lots of examples of fighting ageing. You extend your middle age—it’s like people who exercise better, eat healthy and so on. But reversing ageing is unusual.

And that’s the other area where companies can do things that a human being cannot. You cannot reverse ageing as a human being. You can be a youthful 87-year old but you still will be 87. But if you take a company like Apple, in 2000, it looked like its best days were behind it. But it found an entirely new life and came out with the iPhone. Or take Microsoft, which looked like a two-hit wonder in 2013, but later turned around its fortunes. These firms became legendary companies. Their CEOs became case studies, had movies written about them, books written about them and so on.

I have no problem with that. I think they deserve celebration. But then other people read those books and say, ‘if only I did what Steve Jobs did at Apple, I too could reincarnate’. And my point is, reincarnation is a combination of many things coming together. It’s not impossible to replicate, but it’s very difficult.

Usually the process is organic, the new businesses are built from within, rather than being acquired. So when I look at companies who say that they’re going to reincarnate themselves by doing an acquisition...well, it’s possible, but history works against you. When I see a company with the same CEO in place and he says ‘I'm going to be different’, my reaction is skepticism. Also, not to forget, you need luck to be on your side. I tell people what Steve Jobs did at Apple in 2000, if he tried in 2010 or 1990, it would not have worked out.

How do you assess corporate reincarnations in the Indian context? Say a company like Reliance Industries.

Family group companies are not one company, they are a portfolio of companies. You take the Birla group, for example. They have Grasim, Hindalco...these are middle-aged companies. Now middle age doesn’t mean bad. They’re profitable businesses, but they won’t have the same growth potential as say renewables, which is also in the Birla portfolio.

So what happens with family group companies is that rather than thinking of Reliance as one company, think of it as a portfolio of companies. One of the ways to judge the health of a family group is to see whether the portfolio stretches across the lifecycle. There will be declining companies, middle-aged companies, and you need them because they provide the earnings and the cash flows. But you also want some growth companies. If you’re a good family group, you should be having a few startups in there.

Reliance has been very good about keeping that balance, because they could have lived off the petrochemical business. Lot of family groups in India, because they judge a business based on earnings and cash flows, tend to go into mature businesses. If they demand those same metrics from young businesses, they will never take off. So you need a mindset shift, and that requires a diverse set of talents.

The kinds of people you want running young companies have to be very different from those running middle-aged companies. If there’s one person running every company in a family group as the patriarch at the top, I don’t see how you can pull this off.

How can investors identify which stage of the corporate life cycle a company is in?

First, look at the business. For example, Hindalco is in aluminium and Grasim is in textiles. These are mature businesses. Look at the revenue growth, you won’t see 20% or 30% growth, right? You will see high single-digits. A good year might see you barely breaking 11% or 12%. I also look at the margins, these businesses have nice, stable margins. Young companies don’t have nice, steady, stable margins. When you ask a company, all of them say they want to be growth companies, because that’s the fun thing to do. But then I look at what they do, and not what they say.

Valuing a startup is very different from valuing a mature business...

Why do you think this is so?

Well, for starters, sometimes there is no cash flow...

Yes, there’s no financials, there’s no history. Let’s be quite clear—all valuation is about projecting the future. So when you value Grasim, you have 25 years of history, you know what business they’re in, you can look at other companies. You have more crutches.

For startups, there are often no crutches. So you’ve got to come up with estimates using the total market, what the product is and so on. When you pay 10 times revenues for a Paytm or a Zomato, you are making judgments about what the total market will be and what their market share will be, but you're not explicit about it. You just say there’s lots of potential. What I argue is that if you’re going to buy the stock, you have to make your best estimates.

You valued Zomato at ₹42 a share at the time of its listing, which was around half its issue price. The share is above ₹250 now...

Look, given where I was in 2021, it’s what I saw in the company. This is what my estimate of value was. If I value the company today, would it be different? Of course. Now, my valuation of Nvidia that I put out last week was almost two and a half times higher than my valuation 15 months ago. They say, what happened? AI happened, and the size of the AI growth was so explosive that everybody was surprised.

There’s an old saying by John Maynard Keynes— ‘When the facts change, I change my mind.’ Staying with an intrinsic value that’s the same when the world is shifting around you is a sign that you don’t really understand intrinsic value. So you have to be adaptable, you have to be flexible, and you have to remember where to say those three words that I think are the most freeing — “I was wrong”.

Now I’ll tell you what I got wrong with Zomato. I was wrong in two dimensions. One was how much Indians are shifting to eating in restaurants. And I saw that recently in Chennai, where every storefront is a restaurant. I talked to my nieces and nephews and the elderly people, and they don’t even use their kitchens anymore, the shift is dramatic. I grew up in a Chennai where there were maybe five restaurants in the whole city. I remember my grandmother saying ‘why would you eat in a restaurant when your cook can make food exactly the way you want it?’

The second factor is the Blinkit acquisition, which has worked a lot better. It’s a tough business to have groceries delivered at home. The Zomato story is no longer a food delivery business; it’s a last mile business. So if you’re at home, you need to get anything delivered—be it medicines or grocery or a movie ticket—it could be fulfilled by Zomato.

I think Zomato is taking advantage of the infrastructure nightmare that urban settings in India have become with the traffic and the parking and so on. I can see the pain of getting from point A to point B in India, it is just mind boggling. Sometimes it can take an hour to travel four miles. So I think Zomato has the capacity to become that last mile service provider.

I will visit my Zomato valuation at some point in time, and my guess is the value will be higher. Will it be higher than ₹250? I don't know. It might be ₹125, and I might still conclude it’s overvalued. And then people might say ‘But you told us it was ₹42 earlier.’ Well, I didn’t tell them. I value companies for myself. I tell people very clearly that I value companies for an audience of one—myself. I make decisions based on my valuation, and I think it’s a mistake for other people to make decisions based on my valuation, because you’re copying. You need to take ownership of your decisions.

Coming back to the six stages of the corporate life cycle. Are you saying investors should avoid mature businesses altogether?

At the right price, you should buy any business.

So how should investors position themselves? Should most of the portfolio comprise growth companies?

It depends on how old you are and also what you want out of your portfolio. If you want cash flows and dividends, then you shouldn’t be investing in young companies. Now, if you’re younger and you want capital appreciation and you don’t really need the cash from your portfolio, you have the room to invest in young companies, but then accept the fact that those shares will be very volatile. If you’re lying awake at night because your stocks are moving, maybe that’s not for you. There’s no one size fits all.

Often people accidentally end up in the wrong part of the portfolio, and then they wonder why great things are not happening. So if you pick companies based on dividends, and you say ‘Why isn’t my portfolio going up 400% like my neighbour’s’, it’s because you’re in the mature phase and Grasim and Hindalco etc will not quadruple in price, but they will deliver nice steady earnings and cash flows.

We are currently witnessing the birth of AI. But every startup seems to be the ‘next big thing’. How can one separate the wheat from the chaff?

AI is not a business. So when somebody says, I'm in AI, the question to ask is, what are you using AI to do? There's only one company in the world right now that's making money in AI and that’s Nvidia. And there it's concrete. They're making chips. Maybe OpenAI is the other company, but ChatGPT is a freebie right now; it's not making money.

So AI is not a business, just as dotcom was not a business. I’ll tell you something. If everybody has it, nobody has it. What I mean by that is when grocery stores say, ‘we use AI to cut costs’ then we might think that they'll make more money. But if every grocery store uses AI to cut costs, then no one is going to be more profitable than the other, right?

Look at PCs. PCs collectively didn't make companies more profitable. The dotcom revolution didn't make companies more profitable. It created some winners, but for every winner, there were 20 losers. My guess is, when all is said and done, you will have a few really big winners from here. Right now, we've crowned Nvidia and Microsoft, but who knows what that'll be 10 years from now? So if you're an investor, maybe the question I ask is, who are the losers going to be from AI and sell short the losers, rather than try to catch winners.

How does the current market appear to you? Do you think the Indian stock market is overvalued?

Indians are a little irrationally exuberant about the future, isn’t it? I think currently it’s the coming together of some things. One is the slowing down of China. Over the last 20 years, half of all global growth has come from China. And now China is taking a step back, politically and economically. Scale wise, it can’t provide that growth.

And India is perhaps the only country with the potential to step in and do what China did, and the market is pricing in that expectation. China had cracks in its armour but was able to paper them up, because it's an authoritarian system. But in India, the cracks are not just going to be there, but people are going to draw attention to them. Politically, the opposition party will say these things are not working. So it’s going to be more challenging for India to hide those cracks.

What are those cracks?

One is infrastructure. India lags on infrastructure, and it’s not going to be quick to catch up, because you have legal constraints. As a democracy, you can’t just raze entire cities. You’ve got a legal system that is really, really, really slow and a bureaucracy that’s incredibly risk averse. There is the old idea of just passing the files, let it be somebody else’s problem. I think even more than corruption, it’s just risk averse.

Now when the Adani group had its problems, I said it just exploited the weakest seams of the Indian economy. Let’s not act like they’re the only sinners, because these seams get exploited by Indian companies all the time to their advantage.

So I think India is like a startup in terms of life cycle. You can even think of countries in their life cycle. India is in this phase of the life cycle where it has tremendous growth potential, it’s already the fifth largest economy, so it’s not some small startup. It is like a large startup with the potential to kind of explode to the top, and the market is pricing that in. The concern, of course, is if any of these seams kind of cut in the other direction, then you have a challenge.…

Do you think the potential gains outweigh the risks for Indian investors?

What choice do domestic investors have? I mean as an investor who can invest in stocks anywhere in the world, Indian stocks seem rich to me. They are richly priced. Would I rather buy DoorDash than Zomato? Probably, because Zomato is already pricing in the expectation that not only will they succeed, but India will keep growing at 7-8% or 9% a year. It’s built into the pricing of not just Zomato but even let’s say State Bank of India. It’s priced in across the board.

Every bet on an Indian company becomes a joint bet on the Indian company and the Indian economy. And that’s kind of daunting. But Indians don’t have a choice, because while the system has opened up a little bit in terms of being able to invest overseas, it’s not like you can get new brokerage accounts and start buying Facebook shares.

So as an investor who has choices, Indian stocks look awfully expensive. But maybe that's just the top tier, because the India story is so strong that foreign investors want to come in, and they come into companies where they recognize the name and the corporate governance has some degree of transparency. So everybody’s piling into Asian Paints and the ITCs but there’s probably an entire range of Indian companies which are middle or small market caps which could qualify as the only promise for me, investing from the US.

Of course there are issues like governance, where sometimes in a family-controlled company promoters can essentially play the wealth transfer game.

What are some of the themes which you see playing out in the market over the next six months or a year?

US elections in November. That’s going to be the first thing that plays out, because it has consequences. Then there’s China. I think if there’s friction between China and the US, everybody’s going to be a casualty, including India. If there’s a tariff war between China and the US, there’s going to be massive blood on the streets.

And then you’ve got AI creating this background noise of promise. Also, this is why I think the US has an advantage over Europe and much of the rest of the world. Whenever you get one of these new innovations, it comes from the US. Europe is dead in the water because they’re so caught up in preserving their middle-aged companies that they give them incredible advantages. For a startup in Europe, you’re more likely to be consumed by the middle- aged companies.

So one of the things to see for countries is to take their biggest companies and put them in the life cycle framework. And that’s again the advantage the US has. You have 20-year-old companies that have come out of nowhere and become large market cap companies. You go to Brazil, take the top 30 companies, they’re all either old government companies or big financial service companies. There are tech companies, but they tend to be ageing tech companies like Infosys and TCS. So I would love to see a young company make it to that top 20 list of large market cap companies.

Do you think Zomato can be such a company?

I don’t know whether Zomato will be the one, because, after all, it’s a delivery company, and you’re catching the smallest part of the pie that goes out, but there will be someone. If Paytm had played its cards right, it could have been there. So you have to be careful, because you try to be that high growth company, and then you overreach, and then next thing you know, the whole thing blows up on you. It’s a tricky business, so I leave my options open on what that company might be.