The Prof G Pod with Scott Galloway - Prof G Markets: NVIDIA’s Valuation and AI’s Negative Sum Game — with Aswath Damodaran

Episode Date: August 14, 2023

This week on Prof G Markets, Scott speaks with Aswath Damodaran, professor of finance at NYU’s Stern School of Business, about his valuation for NVIDIA, tech’s rally this year, the implications of AI when every company has it, and opportunities in the markets right now. Follow Aswath on Twitter, @AswathDamodaran. Learn more about your ad choices. Visit podcastchoices.com/adchoices

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NMLS 1617539. This week's number, 500,000. That's the record number of passports the U. think, one of our first five-time guests, Aswath Damodaran, Professor of Finance at NYU Stern. We discuss with Aswath his valuation for NVIDIA, AI winners and losers, and his thoughts on tech's historic rally in the first half of the year. Ed, any takeaways from Aswath? I'm just always shocked by how informed he is on basically any stock pick. I mean, you can put any company in front of him, and he has such an informed view. And, you know, he's not just looking at multiples. He's building out his own DCF models and coming up with opinions based on that.

And then the other awesome thing is that he's almost always right. I feel like I've never seen a take from him that I thought was irrational or not sensible. And it always feels like it works out. I mean, I feel like he was the one who at least partly inspired our position on meta that it was undervalued last year. And so I'm just, I love him. Trevor Burrus Trivia question. Who was the first guest on the David Letterman show? Peter Robinson No way I would know.

But may I guess Aswath? No, it wasn't Aswath. It was Bill Murray. So Aswath is our Bill Murray because he was the very first guest on the Prop G pod from the Rosewood Mayakoba in the midst of COVID when I had basically packed my go bag and grabbed my family. Aswath was the first guest on The Property Show. Anyways, enjoy our conversation with Professor of Finance, Aswath Damodaran. Aswath, where does this podcast find you? San Diego. San Diego, that's right. Quick story about San Diego.

I was born in San Diego because my parents, who were living in Toronto, read in the newspaper that San Diego had the nicest weather in North America. So they loaded up their mini metro when my mother was seven months pregnant. And two months later, born in San Diego. So congratulations on living in the city with the best weather in North America. Today's high is 70, today's low is 62. So kind of a sweet spot there. See above San Diego. So first half of the year, the best year for the NASDAQ in 40 years. Just globally, what are your thoughts about the market and what feels like just sort of a run-up that just sort of snuck up on us. I think part of it was a bounce back from last year where I think investors overreacted on tech

companies, knocked their prices down too much. And some of this has come back. I mean, it is highly concentrated. The companies that have come back the most are tech companies, bigger tech companies that make money. This is not a full comeback of risk capital in the traditional sense where people are piling into everything tech. It's a very selective run-up in tech companies. So there's been a redistribution of value among tech companies from money losing smaller tech companies to money making larger tech companies. So it looks like a tech comeback, but it's a very different comeback than the drawdown we saw last year. It feels like animal spirits are coming back

into the markets. Your thoughts? There's some of that and some of the recognition that these big tech companies have incredible amounts of buffer. That's what we realized last year, that you could lay off 10,000 employees without a dent to your revenues, that they'd built up a lot of fat on the way up. And essentially, when they cut costs, that cost cutting is almost costless from a revenue perspective. So I think that these tech companies had an incredible amount of fat to burn off. And as they've burnt it off, markets have recognized they still stay profitable. They still deliver the margins they used to. And a lot fewer people employed at them. But I think that that's the recognition you're seeing rewarded this year.

When you're on the show or when you're on the pod, we talk a lot about the same names. Apple, Meta, some of the bigger players. Give us your thoughts around valuation and the company NVIDIA. I think NVIDIA has been a stock that I've had in my portfolio now for five years. And when you talk about the online and the social media revolution, somebody's got to provide the infrastructure to make it run. In the 1990s, the peak of the dot-com boom, people forget that the company that reached the highest market cap was Cisco, a company that had nothing to do with the online retail and other space, but the infrastructure for online. NVIDIA, in many ways, has powered the tech growth for this year by providing the infrastructure,

the hardware to make it happen. And I describe it as my opportunistic chip company. While the rest of the chip makers were kind of looking at a market that had slowed down in terms of growth. NVIDIA always seemed to be in the right place at the right time for new markets, whether that was gaming or whether it was crypto and now with AI. The first time around, you can say they were lucky, but by the time you get to the third time around, this is by design. I mean, this is a company that's been opportunistic in going after markets that are just taking off and have been able to benefit from those markets. So that's why I bought NVIDIA in 2018, because of their opportunistic streak in the company. And at the time, the price had also been knocked down. This is, again,

something that people forget with these highly priced companies. They act like these companies would never be touchable as investments. But the reality is, you look at the history of NVIDIA, it's had two near-death experiences in the last 20 years, dropping 80% in market cap twice. And in 2018, they lost 40% of the market cap. So even these companies look and say, I would never have been able to buy that stock. There was a time in the last 15 years where you'd have been able to buy the stock. And I think that's a lesson that if you're a value investor, you need to take away is you cannot just take these stocks off the list of companies you're

interested in investing in because at the right price, they are great investments. I know I got lucky in NVIDIA because I had no idea AI was coming, but I bought the fact that they would find a way to be in that next big market when it came along. Hi, Aswath. Thanks for joining us. I also have a question. I read your recent blog, your blog Musings on Markets, and you wrote about AI's winners and losers, and you wrote about NVIDIA. And the conclusion that you reached at the end of the blog was that even if you assume this very highly bullish stance on the AI market as a whole, as well as assuming that NVIDIA will continue to maintain relative dominance in the market, in the AI chip market. If you assume all of that, you still believe that that current

$420 price point is still too high. Could you take us through your thesis there and how you concluded that? In a sense, it's a series of estimates, right? So, you know, you take AI, right now it's a $25 billion. If you're lucky, a chip market is about $25 billion. I look for estimates of how big that market could be 10 years out. The biggest number I found was 350 billion. I gave NVIDIA 100% market share of that market, every single chip. And I still couldn't get up to $400 per share. So you almost have to price in another market out there as big as the AI market that we haven't seen yet that NVIDIA is going to be able to jump into. Could that happen? Given the history over the

last decade, I wouldn't rule it out. But if you price that in as an expectation, where's your upside? It's one thing to buy NVIDIA at $150 and say, I'll get the optionality of jumping into that market. It's another thing to pay $400 per share, price in the expectation that there'd be another $350 billion market we haven't even seen yet that they will dominate, and put that into your market cap. And that seems like an incredibly large risk to take if you're an investor jumping in for the first time. Didn't you just describe Tesla? Now, I valued Tesla earlier this year, and I came up, this was right after their travails. And this again goes to my point about these companies go up and down.

There will be points at which Tesla was trading at about $95 per share, $90 per share at their low point. I valued them pretty close to the low point, and I concluded that it was close to fairly valued, perhaps some upside. Now, of course, it's trading at two times that upside. It doesn't surprise me in the least. Tesla is always a company that you overshoot or you undershoot. So you know what? I'll hold my fire on Tesla. I wouldn't be surprised if a year from now, Tesla is back to trading at $95 per share. This is a company that essentially is the equivalent of a manic depressive. You know, you get everybody in a mood where everybody's buying, or you just get everybody

turned down in the stock. But you're right, Tesla is one of those companies where the narrative seems endless when the good times, and it seems to have no place to go in the bad times. And right now, the narrative seems endless. Everybody's piling on. There's an upbeat story about what Tesla is going to pull off, but you are pricing in, not just an expectation that they will dominate the electric car market, but that they will find other markets to take advantage of. And what makes it so difficult to push back is these are plausible stories. It could happen. But investing on the expectation of it could happen seems not to me a great way of investing because you're just, you know, your best case scenario is you get your expectations delivered.

Your worst case scenario is the company's just exceptional, not awesome as you built in. Yeah. What are the prospects for NVIDIA? I mean, how could NVIDIA scale? One of the things that Scott and I have talked about is how NVIDIA? I mean, how could NVIDIA scale? One of the things that Scott and I have talked about is how NVIDIA is not vertically integrated, and that is it designs its chips, but it doesn't build them and outsources the manufacturing to TSMC. Do you think that NVIDIA will need

to vertically integrate at some point? Is that the solution to scale? Like, what is the thing that NVIDIA could do that isn't 100% market share of the AI chip market? I don't think vertical integration is going to do it for them because that's a lower margin commoditized business. And there's a reason they've outsourced it to TSMC,

which raises an interesting country risk question that I don't even want to go into now because they are entirely dependent on Taiwan semiconductors delivering their chips. I think what they need, I mean, let's face it, five years ago, if you talked about the AI market, you said, well, it's not a big market. I don't care. Five years later, people talk about a $300 billion market. Who knows what the next technological shift will be and what architecture we will need. So for it to scale up, you actually need a market we don't even know about yet, like the crypto market, the gaming market, and the AI market. And that's why I said it's conceivable it could happen because it's happened three times in the

last 15 years, markets that came out of nowhere that were big markets that NVIDIA happened to dominate. But you'd actually need something like that. I mean, there's stock that, and I'm not as upbeat about this, about the omniverse. In fact, NVIDIA's CEO talked about the omniverse, metaverse, virtual reality, the kinds of chips you need.

It's not a $300 billion market. That's not big enough. So you need a market as big as what the AI market is seen to be, and NVIDIA to dominate that market for you to be able to get to $400 per share. Well, I was just going to ask, you bought NVIDIA in 2018. Your thesis sounds like it's probably a little overvalued at this point, or at least it's primarily driven by narrative.

What is your recommendation to existing NVIDIA shareholders? I don't advise other people on what to do because they've got to factor in what they think about NVIDIA. I can tell you what I did. I sold half my holding of NVIDIA because I think it's overvalued. And I've made back well over, I mean, seven times what I originally invested in NVIDIA collectively. I've held on to the other half because I think the momentum in this case

is going to mean that the price is not going to collapse 25 or 40%, but it's on watch. Which means that if I truly feel that, if there's any more of a run-up, that half is also ready to leave my portfolio. But I think there's an interesting question about whether we treat investments that are already in our portfolio differently than investments we plan to make for the first

time. It's, I think, something that from a psychological perspective and an investment perspective is worth examining. You saw that at the Berkshire Hathaway meetings, where somebody asked, I think, Charlie Munger, whether he felt comfortable that, I think, about a third of Berkshire Hathaway's portfolio is in Apple. And he said, I'm completely comfortable. I'd wager if you asked him a question, would you feel comfortable taking a third of Berkshire Hathaway's money today and investing in one stock? He would say no. And I think that I'm not saying he's being irrational, but I think it's something where we treat investments that are already in our portfolio differently than investments we

plan to make for the first time. And I was the first one to admit that I was being, you know, internally inconsistent by holding on to half my portfolio. But I think that this way, I think regret is one of those things you worry about as an investor. This way, I get to have my cake and eat it too. If the stock drops, I can say, look, I sold half my stock. If the stock goes up, I can say, look, I held on to half. I know that sounds like something that rational people should not do, but we're human beings. Rationality is the first casualty when it comes to investing. And this happens to be one of those cases. I'm open about the fact that I'm being inconsistent. We'll be right back.

I just don't get it. Just wish someone could do the research on it. Can we figure this out? Hey, y'all. I'm John Blenhill, and I'm hosting a new podcast at Vox called Explain It To Me. Here's how it works. You call our hotline with questions you can't quite answer on your own. We'll investigate and call you back to tell you what we found. We'll bring you the answers you need every Wednesday starting September 18th.

So follow Explain It To Me, presented by Klaviyo. Hey, it's Scott Galloway, and on our podcast, Pivot, we are bringing you a special series about the basics of artificial intelligence. We're answering all your questions. What should you use it for? What tools are right for you? And what privacy issues should you ultimately watch out for? And to help us out, we are joined by Kylie Robeson, the senior AI reporter for The Verge, to give you a primer on how to integrate AI into your life.

So, tune into AI Basics, How and When to Use AI, a special series from Pivot sponsored by AWS, wherever you get your podcasts. Let's stick with AI. You wrote that you believe that AI will be negative some. What did you mean by that? Well, I think that when people talk about AI, they talk about how it'll cut costs for companies. They can replace people with AI and that by cutting costs, they're going to make more money. And I was saying that people are tired of listening to me say, which is if everybody has it, nobody has it. So if everybody has AI and they all cut costs, the problem is somebody is also going to cut prices. And once they start cutting prices, everybody ends up with lower costs and lower prices. Your margins actually decrease because competition takes the upside away.

And it's with the experience that you can look at this history, right? When PCs first came out in the 1980s, we were told about how companies would get more profitable because you could now use PCs to reduce the number of people working at your company. And that reduced cost would turn out as higher profits. Turned out not to be true. Everybody had PCs. Everybody spent more on PCs. Companies didn't come out as more profitable. And each big change, what were promised is this will cut costs, increase profits, everybody will be better off. I think the beneficiaries might be the consumers. So people who use consultants might find themselves paying less for consultants if it's automated, if AI can take over that space.

But I don't think that consulting companies are going to walk away as more profitable. There are going to be a subset of companies that benefit from this growth, just like in the PC business, the dot-com business, the social media business. So I'm sure there will be companies like NVIDIA that can benefit from the growth of AI, but most of the rest of us, I think, will find that AI doesn't deliver the promised profits that are being offered out there right now, because it's not a competitive advantage. Everybody will have access to it. And I'm not sure that means that anybody walks away with an advantage from this space. When you think about the big five, when you think about Apple, Microsoft, Tesla, who else do we have in there? Meta and throw in Netflix.

Do you see value anywhere? Do you think, I mean, it feels as if a small number of stocks have really driven a lot of the indices' returns. To a certain extent, I would argue the indices are not helpful because they give sort of a false impression of what's actually taking place in the market. But when you look at the big guys that we all follow, do you see value anywhere, or do they all seem fairly fully valued? At this point, I wouldn't buy any of them.

I'm lucky enough to own four of the five stocks you named, other than Netflix and Tesla. But I think that at today's prices, I wouldn't go out and buy them. But having them in my portfolio already, I'm not sure I'd sell them either, which is a strange thing to say, saying if you wouldn't buy them at today's prices, why wouldn't you sell them at today's prices, why wouldn't you sell them at today's prices? I have two words, California and taxes, which kind of hold me back. And I think that from that perspective, I think that they are in fact fully priced right now. But I think there will be chances of those people who regret not buying them, there will be a chance again in the

future. I can almost guarantee it because the nature of these stocks is they will go up and they will go down and there will be times at which there will be decent investments again. But right now, I think that they're as fully priced as you can get. And when you look across different geographies and different sectors, do you see any sectors or geographies or specific names where you think this is a good entry point? I was actually doing the table on the breakdown of how 2023 has played out across sectors. And it turns out that technology accounts for a big chunk of the increase in value. And 90% of the increase in technology comes from the very top decile of technology companies, the largest tech companies. So if you look at how much market cap

the rest of the market has gained in 2023, it's not that much. So many of these companies that got knocked down in 2022 have not really recovered most of that drop in value. So I would say look at the left behind companies, the sectors that have, and I think seven of the 12 S&P 500 sectors or the S&P sectors actually are either flat this year or down this year in spite of the market going up. I mean, I would look carefully at those sectors and the companies in those sectors because I think those sectors got marked down in 2022. They haven't come back. And if we truly escape the potential recession that people keep talking about never seems to arrive, many of those companies I think are undervalued, a potential add-on to your portfolio. So I would say look at

the companies that have not benefited from the run-up if you think about an entry point into the market, because I think that's where you're going to see the next leg up in this market. One of those companies that hasn't experienced an updraft, and I don't know if you've looked at it, have you spent any time looking at Snap, Aswath? I have off and on since their IPO. And, you know, it's a space I'm reluctant to enter because online advertising has become this strange, cramped space where it's, you know, it's become zero-sum game. So I think Snap has done reasonably well in holding their own. But, you know, I am reluctant to go into that space because I think anytime you have a zero-sum

game, you're going to have, you know, you can see this with Facebook entering Twitter space right now. But I think Snap's done a pretty good job. Evan Spiegel's got to be given credit for finding a way to kind of hang in there, finding a niche, which is what he should have gone for in the first place. I think that was a mistake he made at the time of the IPOs to think that he was going to be the next Facebook. And I think he's rediscovered that being a niche company in a large market is not a bad space to be. So a high flyer that's sort of near to my heart, because I think it plays an important role in society, and it's one of those companies that's declined dramatically, two brands, Charles Schwab and Moderna. Any thoughts on either of those companies? They're both down

about 30% year-to-date. Schwab, I think the consequences of the banking fiasco was that people started to worry about Schwab as one of the names that was actually thrown around as a bank that might get into trouble. So I think it's still recovering. I don't think it's in danger. In fact, I did buy Schwab because of that reason. I looked at the banks and said, you know what? I think Schwab was thrown into this mix for the wrong reasons. It's not the kind of bank that I would throw in with First Republic or with Silicon Valley Bank in terms of not having sticky deposits. So I think Schwab is a good investment from that perspective because I think it's a solid franchise. It's a franchise that I don't think is going to go away. Moderna, I think it's the COVID letdown.

I think that to the extent that Moderna's price got pushed up because of COVID, to the extent that COVID has retreated from the headlines, companies that benefited from the COVID upsurge, you know, Pfizer, Moderna, are seeing a letdown. The question of whether the letdown is too much depends on how mRNA translates to other. If it's just a vaccine, then I think the letdown is too much depends on how mRNA translates to other. If it's just a vaccine, then I think the letdown is legitimate. But if I think this is the basis for new medications that could come out in the future, I think this might be a good time to take a look at Moderna and saying they have an entry point into new medications that could be used to generate new drugs, new revenues in the future.

But I think at least there are good reasons why you saw the drop down, but that doesn't mean they can't be good investments for people who are willing to have long time horizons. Stay with us. Hello, I'm Esther Perel, psychotherapist and host of the podcast, Where Should We Begin, which delves into the multiple layers of relationships, mostly romantic. But in this special series, I focus on our relationships with our colleagues, business partners, and managers. Listen in as I talk to coworkers facing their own challenges with one another and get the real work done. Tune into Housework, a special series from Where Should We Begin, sponsored by Klaviyo. Support for this show comes from Indeed. If you need to hire, you may need Indeed. Indeed

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thoughts about general portfolio theory? I'll tell you from a personal and a market-wide standpoint. From a personal standpoint, until two years ago, when I had money in my brokerage account, I just let it sit in cash. It just wasn't worth the effort of trying to put in T-bills and make 0.03% a year. For the last two years, I've actually gone to the T-bill auction, taken every dollar of cash that I can take out, put into T-bills. Because when you can make 5.3%, that's cash you're leaving on the table by not investing. The penalty of holding on to cash as cash has suddenly shown up again for the first time in perhaps 10 or 12 years. But from a market-wide perspective, I think this is healthy. I mean, I think of markets as this contest between safety capital

and risk capital. Safety capital is capital that goes into the safest parts of markets. Whether it's in the corporate bond market, you go into AAA-rated bonds, in the stock market, money-making, stable companies, Risk capital is what goes in the riskiest parts of every market. And for a decade, we've tilted the scales in favor of risk capital. Because if you're a safety capital investor, you made nothing on cash. You made low returns on investments. You push money to risk capital. And in my view, risk capital has been too easy for people to access. Too many businesses have been started and funded because risk capital. And in my view, risk capital has been too easy for people to access. Too many businesses have been started and funded because risk capital was so free and easy for everybody

to get. And I think as an economy and as a society, we are going to pay the price for having risk capital being so accessible and so easily available to people. Because I know disruption has been viewed as this great word, but there's always a dark side to people. Because I know disruption has been viewed as this great word, but there's always a dark side to disruption. Existing businesses get changed and sometimes ruined. And that's fine if the new businesses that are coming in are superior in terms of business models. But for a decade, that wasn't the case. We destroyed taxi cabs by bringing in ride sharing. Butsharing as a business hasn't figured out how to make money. And in business after business, we've allowed disruption

to happen with new business models that are not grounded in reality, but funded with immense amounts of risk capital. So in my view, this is healthy, that finally safety capital has a place to go. And in any healthy market, you need a balance between safety and risk capital. And perhaps we'll find a balance in 2023 between the two. So typically, when you have a first half year performance like this, it bodes well for the IPO market for the second half. And in Q2, we had secondary offerings raise triple the amount of money they did in Q2 of last year. Are there any IPOs that you're excited about or any thoughts on the general IPO market in the back half of this year? The interesting thing about 2023 is while

markets have come back, risk capital is not. IPOs, VC money, investment in high-yield bonds, you're not seeing the upsurge you usually see when markets are doing well. Maybe there's going to be a delayed reaction. So maybe the second half is going to be a better period for risk capital than the first half was. So I'm keeping my eye on the IPO market, the venture capital market, the high-yield bond market, because that's where you're going to see risk capital come off the sidelines. I'll be honest, though, I don't think risk capital is going to go back to the way it was in the last decade. And as I said, that's not a bad thing. I think it's going to be much more finessed and focused than it used to be. So I think if you're going to see IPOs, they're going to be businesses that

have at least some kind of business model. At least that's my hope, that you're not going to see the kinds of companies go public that have no business model and essentially just lots of users, lots of subscribers and lots of promise. And hopefully you're not going to see, you know, the kinds of excesses you saw, especially in 2021, where risk capital was so easily inaccessible that people were essentially taking it and creating things that should not have been created in the first place, developments that are not good for the market in the long term. I know the way we take companies public is probably due for a change. I know Bill Gurley has talked about direct listings, but I think that the change is going to be something that's going to take time. It's going to take a while for us to walk away

from a century of how we've gone public. And I can't resist asking, but I'm hoping it's one of the last times I ask, but any thoughts on Bitcoin or crypto in general? It's a currency that nobody uses and a collectible that doesn't behave like a collectible. That part of the story hasn't changed. In fact, what's happened to Bitcoin this year is, I think, the worst advertisement for it to be a collectible. Why? Because it's gone up as stocks have gone up. It goes down when stocks go down. This is not the way a collectible is supposed to behave. It's not a hedge, right? It was advertised as a hedge. Yeah. And if it's a hedge, it's certainly not behaving like one. So, Aswath, you've seen a lot of market cycles. Just based on

your experience, do you have any sort of gut feel for the macro climate or where you think the markets are headed over the next six or 12 months? I think much of it, as it was last year, is going to be determined by how inflation continues to behave for the rest of the year. I mean, so far, it's behaved relatively well in terms of what people thought of as a worst case scenario, which is keep going up. But I don't think it's going to go back to the 2% or 1.5% or 1% the Fed would like it to see. So it's going to be a combination of inflation staying higher than what the Fed expects it to, but lower than it was last year, and how the Fed reacts to it, that you're going to see

effect driving markets for the rest of the year. So I'm afraid you're going to play this game for the rest of the year. Good news is going to be bad news, and bad news is going to be good news, at least for markets. But I think that if nothing else, this year should be in further evidence that experts have no idea what they're talking about. Because at the start of the year, everybody was guaranteeing us a recession. It's almost written in the cards, right? In fact, every market strategist was predicting markets would go down. And markets, as is their want, have shown them all wrong. So the more I watch what markets do and the more I listen to experts tell me what's coming,

the more inclined I am to trust markets over experts. Do you have any thoughts on the yield curve inversion, Aswath? I mean, we're talking about incoming recession, people predicting recession. You'd rather trust the markets. Yield curve inversion would be one of those examples of the markets telling us something, but it didn't happen. What are your thoughts? You know what?

I've always been a skeptic on the yield curve. I remember three years ago writing a piece on the yield curve as a predictor of markets. And I basically concluded that it was a very, very weak predictor of markets. It's become this conventional wisdom. The yield curve is inverted. A recession is coming. But I think that's part of the problem in markets is we still hold on to these rules of thumb, even though we have actual data with us.

You know, let's play some money ball. If we think that having short-term rates be higher than long-term rates is bad for the economy, let's look at all of the data. Let's not use these discrete, you know, rules of thumb of if the yield curve invests, it's almost guaranteed that you're going to have a recession. So I've always been a skeptic, and this year has made me even more skeptical about its predictive power. Aswath Damodaran is the Kirchner Family Chair in Finance Education and Professor of Finance at NYU Stern School of Business, where he teaches corporate finance and valuation. Aswath joins us from San Diego. Aswath, it's always good to see you. Thanks for

your time. Thanks, Scott. This episode was produced by Claire Miller and engineered by Benjamin Spencer. Our executive producers are Jason Stavers and Catherine Dillon. Mia Saverio is our research lead and Drew Burrows is our technical director. Thank you for listening to Property Markets from the Vox Media Podcast Network. Join us on Wednesday for office hours, and we'll be back with a fresh take on markets every Monday. As the world turns And the dark lies In love Support for this podcast comes from Klaviyo.

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