Book Review: Narratives and Numbers.

The Value of Stories in Business

The book shows the importance of connecting qualitative valuation stories and quantitative
valuation models

Book Author: Aswath Damodaran (Professor of Finance, Stern School, NYU)

Book Reviewer: Narahari Hansoge (Assistant Professor, Finance & Accounting, IIM Trichy)

As I usually do in my class, let me start with a simple example. Consider a company that will
generate an equity free cash flow of Rs.100 next year with a perpetual growth rate (g) of 4%
and a cost of capital (CoC) of 10%. Based on these parameters, the equity value today is
Rs.1,667. If you increase g by 1% or decrease CoC by 1%, the value jumps up by 20% to
Rs.2,000. If you decrease g by 1% or increase CoC by 1%, the value decreases by 14% to
Rs.1,429.

A seemingly small change in one of the inputs, changes the final value by a relatively large
amount. Not surprisingly, students find this challenging to understand and are often left with
an impression that valuation is a meaningless exercise where any value can be obtained by
tweaking the inputs. If you have faced a similar conundrum, then this book if for you. Like
many, I consider Damodaran to be one of the foremost valuation experts in the world and this
book is a distilled summary of his experiences and valuation wisdom spanning more than 30
years.

The essence of the book is easily captured in the following sentence from the book - “I think
of valuation as a bridge between stories and numbers, where every story becomes a number
in the valuation and every number in a valuation has a story behind it”. Damodaran’s usage
of the first person throughout the book may be unconventional for a business book but is
entirely warranted as he draws extensively on his own experiences of valuing different
companies. Damodaran demarcates the world into two “tribes” - the storytellers and the
number crunchers. While storytellers can communicate their narratives effectively, they have
a tendency to forget reality. Numbers provide the perfect antidote to runaway stories but a
valuation model built by a number cruncher, who ignores the company’s story or narrative,
will always be on shaky ground. Damodaran argues that for a well thought out valuation, it is
necessary to combine the strengths of both types and avoid the pitfalls of each.

Like all good teachers, Damodaran exhorts the reader to focus on the valuation process rather
than the end result. He achieves this effortlessly by walking the reader through multiple
valuation case studies – starting each case study with the big picture and systematically
narrowing down the narrative to hard numbers. He considers a wide range of companies
including Ferrari (a mature company with an established business model), Vale (a mature
company exposed to the vagaries of macro factors), Alibaba (an emerging market online
behemoth) and Uber (a young company with a new business model in a new industry).

For me, the highlight of the book is his valuation of Uber and his exchange with Bill Gurley,
an early Uber investor. Damodaran uses this episode to drive home three important points –
(i) Valuations are not static but are extremely dynamic. As new information is revealed or as
new developments take place, it is critical to update the valuation narrative and the valuation
numbers, (ii) In order to do that, it is vital to keep the feedback loop open and avoid getting
stuck with one’s original narrative or model and (iii) Valuing young or private companies
(especially in nascent industries) is challenging due to the inherent uncertainty and data
unavailability. However, the potential rewards (both monetary and intellectual) are highest in
this space.

Towards the end of the book, Damodaran discusses his narratives and numbers approach in
the context of valuation driven by macro factors and how the approach can be applied to
companies based on their position in the corporate life cycle. For example, the valuation of a
start-up company will be driven mostly by its narrative as compared to the valuation of a
mature company, where numbers play the dominant role. While most of the book is written
for investors, he also provides a few tips to corporate managers on communicating the right
story and relevant information so that the market can value the company fairly.

One thing which is missing from the book is a good discussion on estimating the cost of
capital. Damodaran takes a rather simplistic approach to arrive at his cost of capital estimates.
Even though discussing cost of capital estimation might have got technical, I would have
liked to see a non-technical summary of various cost of capital models along with a
discussion of applying the narratives and numbers approach to estimate the cost of capital for
different types of companies.

Coming back to the example I gave at the beginning, a valuation approach that
simultaneously incorporates aspects of narratives and numbers provides a stronger
understanding and a sound base to valuation practitioners. Of course, there is no guarantee
that such valuations will always make money for their analysts (capital markets have a mind
of their own!) but the iterative process of ensuring consistency between the valuation
narrative and the valuation model will invariably lead to better thought out valuations. In my
opinion, this book is a must read for anyone even remotely interested in finance. Pick up a
copy of the book and find out yourself!