The Dean of Valuation Talks Tesla -- and College Tuition

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Students are looking at what they're missing about universities. And you know what? The classes are not even making the top 10 list. They're missing the parties, they're missing the football games. So in a sense, what this crisis is doing is it's kind of waking people up. Will it mean that everybody's going to abandon university next year? No, but enough might decide to re-examine whether an education requires a 4-year degree, that it's going to put at least the weaker colleges at substantial risk.

Welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard is Aswath Damodaran. He's a finance professor at New York University's Stern School of Business and a top expert on the subject of valuation. In a moment, we'll hear from Aswath about what Tesla, Amazon, and Bitcoin are worth. He also has thoughts on the value of something that families tend to think about this time of year: a college degree. Listening in is our audio producer, Meta. Hi, Meta.

Hey, Jack.

It's back-to-school season, and when I think back to school, I think of things from when I was a kid. I think of a Super Friends aluminum lunchbox. I think of a loose-leaf binder and a backpack you went to school in Denmark, what do you think about?

I think of like a smelly lunchbox with like mackerel in it and onions, smelly cheese, liver pâté, that kind of thing.

That's like my breakfast these days. The pandemic has made this back-to-school season complicated, of course. I mean, do you send kids back to classrooms? The COVID risk there is hopefully small and controllable, but it's also uncertain. Or do you keep kids at home for online learning? That can strain families. It can cut into the productivity of parents working from home. Some families don't have a choice, and I know thoughtful people who have made decisions in both directions. What's not helpful now, I have to say, are some of the bombastic opinions I keep hearing. My wife showed me an online discussion the other day that more or less been taken over by one commenter writing that sending kids to school during a pandemic was just like murder, and another writing that not fully reopening schools was an act of economic sabotage. It reminded me of a concept I've heard about from psychology that comes up often, I think, in finance and other fields. It's known formally as the Dunning-Kruger effect. Informally, it's called climbing Mount Stupid. In any given field of expertise, you would think that the more you learn, the more confident you become about what you know. If we made a chart of that relationship, it should look like a gently rising ski slope. But just over 2 decades ago, a pair of psychologists ran surveys asking people how they felt about their abilities in a variety of subjects, and then they compared those with tests of actual abilities. And the results of that study did not suggest a gently rising ski slope. They showed that for many people, as soon as they learn a little bit about a subject, their confidence and willingness to share opinions soars. If they continue learning, their confidence actually tends to fall, and later, as they develop mastery, their confidence begins rising again. So picture a line that immediately begins rising almost vertically and hits a sharp peak. That's the top of Mount Stupid, where you'll find people with passionate opinions but little knowledge or expertise. Then the line falls to a deep valley, and that's where you find people saying, "Wow, I didn't know how little I knew until I started learning more." I call that Humble Valley, and I think it's a nice place to be. Few of us are true experts on the subject of how best to return children to school this fall. If there's an online discussion where one person is calling me a murderer if I send my kids to school and another is saying I'm an economic saboteur if I don't, it might be tempting to picture those two people as being on opposite ends of a spectrum of opinions. But I picture them hand in hand with Gore-Tex parkas, ice axes, and crampons, reaching the summit of Mount Stupid together. Me? I'm not perfect, but I try to climb no higher than the foothills of Mount Stupid and to spend as much time in Humble Valley as I can. My plan for school involves being willing to adjust if conditions change and not presuming to know what other parents should do. Now, college students face a different set of decisions. Meta, you You tell me what you would do in this situation. Let's say you're 18 years old and you've gotten into Harvard and you're excited because it's the first time you're gonna live away from home. But now Harvard is asking most of its students to stay home and learn online. Freshmen, it turns out, are getting a choice. You can live on campus, but you still have to take your classes online and you have to take COVID tests every 3 days. You can also defer your admission for a year and hope things are back to normal in fall 2021. By the way, Harvard undergraduate tuition is just under $50,000 a year. If you live on campus, the cost goes up to $72,000 a year, and there are no price cuts for this year. Many students get scholarship money, but not all of them. So, Meta, let's say that you get scholarships and they've cut your cost of going to Harvard in half. Would you go this year or would you put it off?

I'd probably put it off.

Why?

Because I think the school environment is really important. Being at school, working in groups, drinking coffee in the breaks.

Mackerel, don't forget the mackerel. Making friends.

Like, a lot of people meet their significant others when they're in college. You know, all of that stuff is because you're there.

It makes a lot of sense to me. Harvard said recently that 20% of its incoming freshmen were deferring enrollment. For colleges more broadly, I've seen surveys that suggest that as many as 40% of freshmen say they're not likely to go to school this fall. It's possible that a lot of these students don't want to miss out on campus life, but I also think that when we distill college down to just the coursework, which is what's happening during the pandemic, some students and their families question whether they're getting what they're paying for. Now, there's a whole field in finance devoted to just that— what you get versus what you pay for. It's called valuation, and I find it fascinating. Set aside college for a moment and think about stocks. Tesla shares have multiplied 8 times in price over just the past year. They've gone from around $227 to close to $1,900. Now personally, I suspect electric cars are the future because it's more efficient to generate power centrally and store it locally than it is to have an individual power plant under the hood of each car. And I think Tesla is a clear leader in electric cars and further down the road in self-driving cars. We've talked in the podcast about how the pandemic might have extended Tesla's lead because legacy carmakers might have to cut back on investments in future technology to preserve cash. But has the company really become 8 times more valuable over just 1 year? To help me make sense of Tesla and more, I recently called Aswath Damodaran. Hi, it's Jack Howe from Barron's. How are you?

Hi, Jack. How are you?

Aswath teaches finance at NYU's Stern School of Business. He's the author of 4 widely cited books on stock valuation and 2 on corporate finance. On television, he's sometimes introduced as the Dean of Valuation. Aswath says that valuing a business is done by predicting the amount of cash that will come into the business and the amount of cash that will go out. In general, cash that will come in soon is worth more today than cash that will come in later, and cash that's highly likely to come in at some point in the future is worth more today than cash that's only fairly likely to come in. You can use assumptions on those things to calculate a fair amount to pay today for a stock or other asset. Many people who talk to me about stocks will say something like, "This stock trades at 15 times earnings, and other stocks in the same industry trade at 20 times earnings, so this stock looks cheap." They call that valuation, but Aswath calls it pricing, not valuation, and says it's for traders and not investors. He says many stock buyers are traders who delude themselves into thinking that they're investors.

They buy at a low price, sell at a high price, which means they pay lip service to value, but ultimately they're looking for how do I get a higher price in the future? So they go with mood and momentum and trend lines.

So trading is built around pricing, and investing, Aswath says, is built around understanding value and trying to find things that trade below their values. One more question before we get to Tesla. If we want to predict future cash flow for say Coca-Cola, we can look at history and extrapolate because Coke is a predictable business. But what do we do for a young fast-growing company that's barely generating cash or that's burning cash?

People look at storytelling as a bad thing, but with companies like those young companies, you have to tell a story because without a story you can't estimate what they will do in the future. That's, I think, what makes people terrified about young companies is they don't like to make estimates. They like the crutch of past data and just projecting things out. But you will be cutting out entire segments of the market if you do that because you will never buy those companies.

I like Aswath's use of the term storytelling. I think Wall Street in general is prone to physics envy. Financial practitioners sometimes use over-mathematization and jargon to convey a false sense of certainty. But valuing fast-growing companies relies necessarily on storytelling, and stories can be wrong. In other words, even if you're one of the world's leading authorities on valuation, it's good to not stray too far from Humble Valley. Aswath has calculated the value of Tesla in each of the past 7 years, and he calls it the ultimate story stock.

When I first valued Tesla, I valued it as a luxury automobile company because that's what I thought it did. And about 2 years later, when batteries became a big part of their business, I mean, there was a question of, is it really a car company or is it a green energy company? And then along the way, you know, you got the Model 3 at a $35,000 price. So basically what I'm trying to say is my story for Tesla has changed over time as the company has changed and the facts have changed. And as my story changes, my cash flows, growth, and value will also change.

Aswath says Tesla's valuation is made more complicated by its visionary, unpredictable CEO, Elon Musk.

Just when you think you've got the company kind of nailed down in terms of story, he throws a wild card into the mix. Sometimes a wild card damages the story, sometimes it helps the story. It's a fascinating company to value because your valuation, even if you do everything right, is going to jump around like crazy, and mine has.

Oswald says he found Tesla to be overvalued for much of its history, but he bought shares in June 2019, almost a year after Musk's famous 420 tweet. That's the one where he tweeted, "Am considering taking Tesla private at $420. Funding secured." The SEC issuing a $20 million fine to Tesla over Elon Musk's infamous funding secured tweet, which didn't turn out to be so true. Elon regrets— well, he actually regrets nothing. In a series of tweets, the outspoken CEO said the stock jumped 11% that day and closed near $380. But then nothing came of the buyout tweet, and investors were rattled. The stock price fell to around $180 by June 2019 when Oswath bought. He says he wasn't comfortable with how Musk was running things, but he felt the stock was undervalued. He told the story publicly, and he says he went from being attacked online by investors to being attacked online by different investors.

There's no middle ground with Tesla, which means I'm always labeled as too pessimistic by one side and too optimistic by the other. But I really don't care what other people think because ultimately it's my money. My investment, my story that drives my decision.

By the way, Aswath updated his numbers in April based on his belief that the pandemic has made Tesla more valuable. He says the tough economy has kneecapped competitors and given Tesla the kind of opening Amazon had after the dot-com stock bust when retailers pulled back from e-commerce. Aswath's new value for Tesla is $625 a share, That's less than 1/3 of the stock's recent price. Oh, and that $420 tweet? Tesla settled fraud charges with securities regulators over that, but it still faces a class-action lawsuit. Yes, investors are suing Musk for falsely claiming to be able to secure a particular price, even though that price is now less than 1/4 of Tesla's actual price. That doesn't rank among the top 5 bizarre things I've seen this year in the financial world, but it's still pretty bizarre. Aswath has advice for anyone looking to get started in valuation.

Don't start with Tesla. You're going to drive yourself crazy. Start small. Start with a company you truly understand and build a story and evaluation around it.

The other company investors shouldn't start with, says Aswath, is Amazon. That one he has bought and sold 4 times and made money each time, but he says he hasn't owned it in a while. He calls it a terrifying company to value and to compete against.

When I first valued Amazon in 1997, I valued it as an online book retailer. That's how old my valuations go. Then it became an online retailer, and somewhere around 2012, Amazon made a transition that makes it really difficult to value. It became a disruption platform with an army, and the army is called Amazon Prime.

Amazon can turn its Prime customers loose on any new business it wants to go into. Aswath says that when that happens, competitors should get on their knees and pray because Amazon might never figure out how to make a profit in that business, but it can drive other companies out of business in the process. Aswath was working on a fresh valuation for Amazon at the time of our conversation, but he said it would likely come out around $2,000 a share. The stock recently traded above $3,200. Anyone up for valuing Bitcoin? Well, it doesn't have any cash flow. Aswath says Bitcoin was perceived as a crisis currency, but that lately it has acted like a stock, only more volatile. He says it's not proving its worth as a currency either.

It's failed miserably because to me, the test of a good currency is do people use it for transactions? And 12 years after Bitcoin has been invented, I'm still hard-pressed to find anybody who's actually paid for something with Bitcoin or been paid in Bitcoin.

That brings us back to college. More than 10 years ago, I wrote a column arguing that college had gotten too expensive. That's not a particularly controversial view, but I wrote that it had gotten so expensive that the financial payoff of a degree was no longer a sure thing. I used the hypothetical example of two students, Ernie and Bill, who, with help from their families, have put together some modest savings for college. Only Ernie invested his college savings in the stock market and went to work right out of high school. Bill went to 4 years of college. I made the math as fair as I could. I assumed 2 years of public college and 2 years of private using average prices. I didn't count room and board, and I factored in average size grants to reduce the tuition and average size loans when college was done. For both, I assumed average earnings for their education levels for each year of their careers and a modest percentage in yearly savings. The upshot was that when the two met at a retirement party at age 65, Ernie, who had skipped college, had $1.3 million in savings, and Bill had one-third as much. How's that? Well, Bill made significantly more money than Ernie every year of his life, but he started working years later, and it took him another 12 years of savings just to pay off his student loans. He never made up the difference. While Ernie was busy earning, I wrote, Bill got stuck under his bill. It was a simple example. I didn't account for the many non-financial benefits of going to college, like career satisfaction and statistically better health. For me, financially and otherwise, college has been a great deal. But I also didn't adjust my numbers for the fact that Many students don't graduate after 4 years, or at all. My point wasn't that students shouldn't go to college. It was, if anything, that you have to go if you can, but the pricing seems unfair. A newspaper asked if it could republish the column in its opinion pages. I said, "Sure, but please use a headline that doesn't make me sound like I'm against college." The column ran with the headline, Don't get that college degree! Exclamation point. Since that story ran, tuition, fees, room and board have climbed by an average of 45% at 4-year public colleges and 43% at 4-year private colleges. That's about double the rate of inflation. I'm still pro-college, but it seems weird to me that For example, some colleges charge thousands of dollars for a calculus class, even though the rules of calculus haven't changed much in 3.5 centuries, and course materials including video lectures are available online for free. It has always seemed strange to me that our best schools are the ones that admit only 5% or so of the students who apply. Why hasn't the internet expanded capacity? If a hospital turns away the sickest 95% of patients, should we marvel at how well it does with the patients it lets in? All right, maybe that last hypothetical goes a little too far. The point is, I'm pretty sure the pricing power of colleges doesn't come from their ability to teach. It comes from their ability to turn away most students and brand the rest for lifelong success. And in America, we only ever seem to have one answer when we want to make something more affordable. We artificially puff up buying power using subsidies, tax perks, and cheap financing while leaving supply constrained. That results in even higher prices and less affordability. Think housing and healthcare. The last thing I want to do is knock college when it's having a difficult moment. But I've been wondering for years if college is headed for a price crash, only I couldn't figure out what the catalyst would be. Could the fall shutdown be that catalyst? I asked Aswath if he had any thoughts. He did, and he wasn't shy about them. He said that if education were looked at as a business, it would be, in his words, the worst business ever created because the model makes no sense. Aswath says universities have, again in his words, a lack of consistency in decision-making, screwed up governance, and out-of-control cost structures. Funding, he says, is unsustainable. He says education as a business would have been restructured 100 years ago, but it has survived as a monopoly thanks to inertia.

People are trained to believe that if their kids have to be educated, they have to go through a 4-year university degree. I mean, it's almost been ingrained. So if you are a 19-year-old and you went to your parents and said, look, I've decided not to go to college, I would wager that 80% of parents, perhaps more, would freak out saying, no, no, no, you have to go to college. That's what an education is.

The college system was supposed to be challenged more than a decade ago by online learning. But it hasn't happened. Now Oswalt says things are different.

What's different about this crisis is for the first time the inertia might be getting shaken because parents are seeing their kids at home and recognizing how little substance there is behind so many university classes. Students are looking at what they're missing about universities, and you know what? The classes are not even making the top 10. They're missing the parties, they're missing the football games. So in a sense, what this crisis is doing is it's kind of waking people up. Will it mean that everybody is going to abandon university next year? No, but enough might decide to re-examine whether an education requires a 4-year degree that it's going to put at least the weaker colleges at substantial risk.

Finally, I asked Aswath what he thought about the valuation of a college degree. And before we hear his answer, let me just say two things. First, when I say I still view higher education as valuable, I don't just mean trade schools and the like. Those are great for many students, but I'm talking about a liberal arts education with subjects that aren't typically associated with a financial payoff, like history and civics. If there's a restructuring coming for college, I hope it results in quality education available more broadly and for a lot less. And second, if you want to learn finance and valuation from Aswath, you can do it for free online, even if you don't go to NYU. Just Google Demodaran Online Foundations of Finance. Now here's Aswath on the value of college.

If a kid of mine came in and said, you know, XYZ State University has accepted me, but I have to pay $40,000 a year for the next 4 years, economically it makes absolutely no sense. And now that economics is going to be backed up by the recognition that maybe you can get an education without going 4 years. The Yales, the Harvards, even the NYUs might survive. But I think that as you go further down the hierarchy, the smaller colleges or colleges without the prestige and the brand name are going to find themselves under assault, and you're already starting to see this happen. So I think that's the thing that this crisis has done that other threats in the past have not been able to. It's kind of forced people to re-examine, does an education require a 4-year university? And the answer is no. And I think a lot of people are waking up to that.

We'll skip the listener question this week because I've rambled on too long, but the word on the street is that there's an all-listener question episode coming in a couple of weeks because Meta's gonna be on vacation. That's the word anyhow. So keep the questions coming. Just tape on your phone, use the voice memo app, and send an email to jack.hough, that's H-O-U-G-H, at barons.com. Thank you for listening. Meta Lutzov is our producer. Subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, write us a review. If you want to find out about new stories and new podcast episodes, you can follow me on Twitter. That's @jackhoug. See you next week.

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