Aswath Damodaran: How to Value Companies in a Crisis
Market turmoil creates the biggest opportunities for smart investors, according to NYU finance professor Aswath Damodaran. The renowned valuation
Market turmoil creates the biggest opportunities for smart investors, according to NYU finance professor Aswath Damodaran. The renowned valuation expert argues that learning how to value companies during uncertainty offers the greatest potential returns for those willing to work when others won’t.
Target Crisis Moments for Maximum Opportunity
“Go where it’s darkest,” Damodaran tells his students. His investment record backs up this philosophy. He bought NVIDIA at $27 per share in 2018 during one of the company’s major downturns and purchased Meta in November 2022 when shares hit $90.
The principle is simple: uncertainty freezes most investors, creating pricing errors that careful analysis can exploit. When everyone else claims they can’t figure out how to value companies during a crisis, that’s exactly when valuation becomes most profitable.
Damodaran explains that whilst each generation believes it faces unprecedented change, uncertainty has always been constant. The difference today is that we’re aware of every change happening globally through instant communication.
Build Proper Discount Rates
Most investors make a critical error by using arbitrary discount rates. Damodaran warns against demanding flat returns like 10% regardless of market conditions.
“When you make up these numbers, you’re just reflecting how old you are as an investor,” he states. Older investors who lived through high-return periods often demand unrealistic returns that keep them holding cash during low interest rate environments.
Learning how to value companies properly requires building discount rates systematically. Start with the risk-free rate from government bonds, then add an equity risk premium based on current market conditions. This ensures your required returns adjust with economic changes rather than being stuck in outdated expectations.
When interest rates were near zero, settling for 7% stock returns made sense because bonds offered only 2%. But when T-bills deliver 5% and bonds offer 4%, you need higher stock returns to justify the additional risk.
Assess Growth Investment Quality
Companies that reinvest heavily instead of paying dividends require special analysis. Damodaran emphasises that growth alone creates no value. The crucial question is whether companies earn more than their cost of capital on reinvestments.
“For growth to create value, you’ve got to earn more than it costs you to raise your money,” he explains. Too many analysts get impressed by growth rates without examining investment efficiency.
Understanding how to value companies that reinvest requires examining three factors:
- What they’re investing to achieve growth
- Whether investments generate returns above their cost of capital
- How sustainable their competitive advantages are
Companies can easily grow by acquiring others at high prices, but this destroys value. Smart analysis separates efficient growth from wasteful expansion.
Manage Winning Positions Strategically
Damodaran’s approach to handling successful investments offers practical guidance. When NVIDIA surged to $410, he sold half despite believing the stock was overvalued.
His reasoning combined analysis with psychology. From a valuation perspective, NVIDIA had few plausible scenarios justifying the high price. But the company’s history of entering new markets created “optionality” that made holding some shares sensible.
Psychologically, selling half eliminated regret risk. If shares continued rising, he still participated. If they fell, he avoided larger losses. This acknowledges that perfect timing is impossible whilst managing emotional decision-making.
“I’d rather be transparently wrong than opaquely right,” Damodaran says, explaining why he documents his reasoning publicly rather than using vague language that provides escape routes.
Handle Political and Regulatory Risks
Traditional models struggle with companies facing government intervention. Damodaran’s analysis of Chinese firms like Alibaba demonstrates better approaches.
Rather than inflating discount rates, build different scenarios into expected cash flows. With Chinese companies, factor in realistic probabilities that Beijing might disrupt business models for political reasons.
“Discount rates are not receptacles for all your hopes and fears,” he warns. Specific risks require specific analysis through probability scenarios, not blanket rate adjustments.
For regulated companies, value them under existing regulations and under potential changes, then calculate expected value across scenarios. This provides more realistic assessments than arbitrary rate increases.
Find Market Perception Gaps
Successful investing requires identifying mismatches between your company assessment and market pricing. Damodaran uses a simple framework: classify companies from “awesome” to “awful” based on analysis, then compare to market pricing.
An awesome company trading at prices reflecting its quality offers no bargain. But a decent company the market considers terrible might offer substantial returns if your assessment is correct.
This explains why he focuses on companies after dramatic price movements. An 80% stock decline doesn’t guarantee value, but increases the likelihood of pricing mismatches worth investigating.
Learning how to value companies effectively means looking for these perception gaps rather than simply buying “good” companies at any price.
Use Statistics as Your Edge
Damodaran argues statistics provides the biggest advantage in modern investing. Markets flood investors with contradictory information pulling in different directions. Statistics offers tools to cut through noise and identify genuine patterns.
“Our problem is not having too little information. We have too much information pulling in contradictory ways,” he explains. One metric says cheap, another says expensive. Statistics helps navigate this confusion.
He recommends investors spend time learning statistical tools rather than reading more investment biographies. Understanding how to assess data properly – both numbers and qualitative information – matters more than studying past success stories.
Implement a Systematic Process
Mastering how to value companies during uncertain times requires following Damodaran’s systematic approach:
Focus on companies experiencing significant events like management changes, product launches, or major stock moves. These situations often create pricing inefficiencies that generate opportunities.
Build valuations from fundamentals rather than market comparisons. Understand the business model, competitive position, and reinvestment requirements before determining value.
Accept you’ll sometimes be wrong, but ensure your process identifies when circumstances change. Every investment should periodically prove why it belongs in your portfolio.
Maintain emotional discipline by separating investing from trading. Choose which approach suits your temperament and stick with it. Trying to do both typically produces poor results.
Avoid Common Pitfalls
Several mistakes undermine valuation efforts. Don’t get fixated on tangible versus intangible assets – focus on cash flows regardless of their source. A patent generating predictable cash flows can be easier to value than a factory with volatile output.
Be sceptical of “adjusted EBITDA” figures that always make companies look better. Honest adjustments should sometimes lower reported numbers. Do your own homework on what adjustments make sense.
Don’t assume mean reversion will solve problems. The 20th century US economy was unusually predictable, but global markets operate differently. Historical patterns may not repeat in changed circumstances.
The Bottom Line
Market uncertainty rewards those willing to work when others retreat. By developing systematic valuation approaches, managing psychological biases, and focusing on fundamental analysis, investors can profit from chaos that scares the crowd.
Understanding how to value companies during crisis isn’t about predicting the future – it’s about making reasonable estimates when information is scarce and emotions run high. As Damodaran puts it: “The payoff to doing valuation is greatest when people feel most uncertain.”
The challenge lies in building the discipline and skills to analyse systematically when conventional wisdom says it’s impossible.
