Why valuation guru Aswath Damodaran sees a long winter ahead for the market

Aswath Damodaran (Illustration by Suneesh Kalarickal)

Aswath Damodaran, dubbed as valuation guru, believes that the ongoing market correction, especially in the riskier stocks, is long-term similar to what we saw after the dot-com of early 2000s bust and the 2008-10 global financial crisis.

“Unlike a virus, where a vaccine may provide at least the semblance of a quick cure, inflation, once unleashed, has no quick fix,” said Damodaran in his blog on Friday. “Moreover, now that the inflation has reared its head, neither central banks, nor governments, can provide the boosts that they were able to in 2020 and may even have to take actions that make things worse, rather than better.”

As inflation and recession fears have mounted, equity markets are down significantly around the world, including in India that is down about 15 percent from their all-time highs reached last October.

The drop in pricing has been greatest in the riskiest segments – defined by Damodaran as companies that are burning cash to earn and grow rapidly – of the market. In comparison, mature and stable stocks have fared a lot better.

This has happened because of a rising aversion in investors, from retail to private equity, towards riskier assets. For instance, cryptocurrencies have imploded and are now trading close to their 2017 levels. Similarly stocks like Zomato, Paytm and PB Fintech are trading at a fraction of their all-time high levels. Investors who bet on startups have also become cautious.

Damodaran, a professor of finance at the Stern School of Business, New York University, believes the long winter is likely to be good for the market.

“I do think that a return of fear and a longer term pullback in risk capital is healthy for markets and the economy, since risk capital providers (that is those who invest in riskier assets), spoiled by a decade or more of easy returns, have become lazy and sloppy in their pricing and trading decisions, and have, in the process, skewed capital allocation in the economy,” said Damodaran.

Following the market crash in 2008, stocks in many parts of the world have been on a secular bull run, though punctuated by intermittent corrections. The Sensex is up almost seven times since then, while the Nasdaq 100, comprising top technology stocks listed in the US, is up nearly 10-fold, despite the recent sell-off.

But, things may not be the same now as easy money has been made.

“If a long-term slowdown is on the cards, then it is almost certain that the investment strategies that delivered high returns in the last decade will no longer work in this new environment, and that old lessons, dismissed as outdated just a few years ago, may need to be relearned,” Damodaran pointed out.

Many analysts believe that the ongoing correction in the market could be the right time to load up on quality names – referring to what Damodaran says are safety capital, i.e., stocks of stable money-making companies that have a history of paying large dividends.

No wonder, even amid the carnage in the overall market, stocks like ITC that have long underperformed the market have become the most sought after. The FMCG giant is up 31 percent in the current year so far.