oh person everything's in person the early final no it's in 170 yeah Prett yeah 11:15 to 150 170 yeah okay folks welcome back for the last time so um couple of things one is you know reminder on the on the two final exams the regular final exam is next Monday I've had two times sent to me by the administration one said 10:30 12:30 and the other said 11:15 to 1115 they've told me it's 11:15 to 1115 don't ask me why they have the strange timing so next Monday is the final exam 11:15 to 1:15 the there is an early final if you're taking that option this Wednesday day after tomorrow in 170 so don't come waiting here saying where is the final it's in 170 from 11 now final exams week this room becomes incredibly difficult to get so I had to get 170 should be plenty of room I think 60 of you or 55 have signed up if you feel you're not ready don't worry just pull your name off just come for the regular exam so you know so or if you want to add on you feel you're either way let me know okay your project is technically due by 5:00 p.m. but if it comes at 5:30 6 6:30 seven8 I'm not going to say look it's late I'm going to take points off get it into me as soon as you can for your own good because as long as the project is hanging over your head you can't get ready for the exam so you want to get it out of the door so try to get it out and again reminder please send it as a PDF file it makes my grading a lot easier it's easier to put comments into a PDF than a word or a PowerPoint so even if you're prepared in PowerPoint just save it as a PDF file okay so today I'm going to actually use the numbers you turned in as the basis for reviewing the entire class you know how when you get an email from an investment bank and if you worked in Investment Bank at the end of the email there is this wrong long disclaimer about all the things they will not be held responsible for so before I show you the numbers I will not be responsible for strange numbers because they are your numbers I did not do any editorial fixing even if I thought a number was strange I think the only thing I fixed was an r squared of 3,630 per. which I think was 36.3 if you really meant it to be 3,630 I would love to know how you got there because we could write a paper in statistics get it published or how we went beyond 100% so for the I've just taken your numbers and essentially I'm going to give them back to you but much of this class is about getting perspective perspective in what sense I know when you walked into the class if I told your company is no dead say well is that is that strange is that common one of the things you get as you look across companies is a sense of what's typical what's strange what's high what's low so as you look at the numbers across the class think about where your company Falls but also look at the distribution CU you're going to see 200 companies from around the world you're going to see very different perspectives player so let's um let's start with a with a with the very simple reason why I give this project it's a pain in the neck it's a lot of work and you're saying I wish it were a nice compact case and the reason I think it's good to get your hands dirty with the real company is the real world is a messy place and you found it out very quickly right there are very few facts on the ground in fact outside of the t-bond rate and even that is debatable as a fact everything else is kind of hazy it's it's a it's it's subjective you got to make judgment calls and in fact when you look look at different Services they give you different numbers for the same fact right especially when you look at things like ratios you look at Bloomberg's debt to cap ratio because and one of the things I hope you get out of this is never trust somebody else's computation of a ratio P you think oh everybody's got the same number not necessarily it's not that you do it better but when you do it yourself at least you know what went into the numerator and the denominator second as you went through this class for your companies real things happened to your company again a pain in the neck I know quite a few got earnings reports on Thursday and Friday and I got frantic email saying should I update everything and I said are you out of your mind you want to open open up that can of worms now you know but the truth is if this were a real decision you had to make you would be updating and things would be changing and it's not just financials that are coming out I don't think did anybody do Paramount in this class okay that would have been an interesting case study in real life because talk about corporate governance nightmares right you're familiar with with Paramount Paramount is controlled by Sherry redstone does anybody know how she ended up with that control yes her husband right or her her father or her husband subar Redstone father maybe yeah father started the compy not really started the company but it was the old Viacom in the 1980s and they vacom issued two classes of shares and at that time Saar Redstone was viewed as kind of a genius so you know what people did right he's a genius what's a harm in giving him voting rights they gave him the voting rights in control of the company and then sna got older and people got surprised he's getting older yeah he's getting older and then he developed dementia and Sher Redstone stepped in and made decisions for him and then when he died the shares went to Sher Redstone so now when you look at Paramount it's a hot mess I've never seen a company with this much stuff floating around where nothing seems to be happening on the ground and just last week you had a fiasco of you know where Sher Redstone pushed out the CEO that she had hand selected because she wants one deal over another because it'll make her better off and there's nothing you can do about it the nature of real companies is real things happen to real companies you got to roll with the punches it's not something that it's not a conspiracy but it might have felt like that that the managers were conspiring to make your life difficult on this project trust me you were not even on their radar but as a side effect that's what you saw and finally I you know I did do some spoon feeding on the spreadsheets and I did it intentionally I don't did not want you to spend this entire class learning Excel partly because it's a useless skill by itself I mean sooner or later it's going to be something that you know the AI is going to do chat GPD is going to do so if you mastered all the keys on the PC on how to turn things in Excel congratulations rest on your laurels for like 15 minutes that moment is gone but at the same time I tried to to to tell you that they shouldn't become black boxes and in the you know especially in the last week some of those spreadsheets became black boxes you fed numbers in the optimal capital structure spreadsheet it came up with the numb I don't know what happened there but I'd like you to step back and remember all of these spreadsheets all of these models are your tools it's not the other way around the model works for you you don't work for the model and I know you've already written your report but as I read the report if I see the word the model came up with an optimal debt ratio of 30% I know exactly what you're trying to do you're saying it's not my fault your model did this I can't explain it but you want get over that in a sense if the model delivers something even though in this project say you can blame the model some point youve got to band and this is something I see Bankers do essentially the model value the company had the models are your tools not the other way around so when I asked you to pick a company I you know I let you pick whatever company you wanted and as you look at that Google shared spreadsheet you probably notice there are other people who pick the same company these were the most pick companies I don't know what it is about this lululand every year for the last decade it shows up on there right it's a fixation almost he but it's it's up there Nike Salesforce Starbucks Spotify Netflix other than Starbuck other than Salesforce notice that these are companies that you are know every day you run into them so in a sense what you see there is a reflection of the fact that we tend to gravitate towards things we understand in fact in investing there are these studies that show that there is a local bias that when you invest you tend to invest in companies not just in your country but that are close to you that you're familiar with we gravitate towards a familiar now somewhere in the middle of the semester I don't know who it was who noticed that there were three other people doing the same company say and they emailed me and said are you know why are you letting multiple people do the same same company aren't you worried that they might you know here's why it doesn't matter to me there were four people who did lulon there's the number it's not a single number one not one okay so some of them are pretty close but don't take it so if you're the 30 37% you still have time that looks a little off right so you might want to check to see whether there's something going on but you can see that the numbers don't match up why partly because you don't all do it things at the same time remember the t- bond rate used was that I can tell when you did your project by just looking at your T bond rate if I see a 4.73% you really put this off to the very end didn't you if you had 4.4% you got it done probably too early because you did it in February again I'm not you didn't have to use the T same T bond rate but you can see the numbers vary not just on your risk free rate but on things like the beta when you did a bottomup beta the way you come up with businesses the weights you attach so it never bothers me when multiple people do the same company in fact as I read the report I'm looking for nuance that you bring to those numbers that might lead you to different destination so let's go back to the very beginning we spent the first three sessions of this class talking about corporate governance and if you step back what we really talking about is the fact that there are multiple players and companies with very different interests managers have their own interests they want to maximize their human capital their compet and doesn't make them bad people human beings are driven by self-interest any any system that acts like self-interest doesn't matter is destined to fail so managers have their own self-interest stockholders have their own self-interest lenders have and what you have in a company is if you don't align those interest there will be times when one group makes decisions that makes the other group or and in particular we focused on the relationship between shareholders and managers we talked about the fact that managers are not know if they feel that shareholders have little power over them put their interest over shareholder interest and we looked at lots of different things to make that assessment but ultimately it's a subjective judgment keep that in mind when you see corporate governance scores people act like oh the corporate governance score is high that must it's a judgment call because you look at the board of directors you look at the voting and non- voting shares you look at the history of the company and ultimately say in this company where does the power lie that's really what I asked you to make as a final judgment so all of those things lead up and I asked you between zero and two to give me a sense of where does the power lie zero being shareholders having no power two being complete power and you can see those are very tiny slices and most of your companies fell somewhere in the middle some power and and so basically the more power is the 1.5 so that was in fact the median but you can see the spread across companies when I look at your reports I actually keep a secondary tab of US versus foreign company so if I can see generally speaking the qu shareholder power is less in family control companies because for obvious reasons but you see the differences start to play out across companies and then I ask you who your marginal investor is somebody I mean by this time it should be Justin who what what is a marginal investor trades and trades a lot right so if I trade 100 shares every 15 minutes I can't become the margin investor I can't move the price you have lots of shares and you trade why do we care GMA why do we care who the modul investor is it's a much more pragmatic Justin basically this is the lead into all our risk and return models right because in all our risk the minute use beta what are you already assuming that the people looking at this company look at only the risk you cannot diversify away which is okay if your marginal investor is Diversified and luckily for you 91% of the companies an Institutional Investor was your modular investor remember you're not looking for a name on the Institutional Investor it's not Vanguard who's your modular investor it's Institutional Investor because institutional investors can keep shifting on you it can be Vanguard today Black Rock tomorrow State Street the day after but they're all investors who likely be Diversified which allows me to use betas there were a few companies with had insiders and individuals in there you're still probably going to use betas but you're going to hold your nose while you do it because there will be times when the beta might underestimate the risk of this company it's more like a private company especially if you're doing I don't think any of you pick very closely held companies where 93 95% of the shares are held by The Insider you even wonder why these companies are listed I think they're listed to get a market price so that The Insider can go around say I'm worth a billion I'm worth 500 million these are really private companies masquerading as public companies I mean India has thousands of publicly traded stocks I think half of them are there just to get the listing in the market cap there's almost no float no trading so the reason we care about marginal investors is to get a sense of are we okay assuming that the only risk that gets priced in is the risk you cannot diversify away so that leads us right into the risk discussion so if you think about it there are two components of capital cost of equity and cost of Deb the cost of equity you start with the risk free rate no default risk longterm now the natural followup to that is let's use a government bond rate and sometimes you can get away with it right what are the what are the requirements for the Government Bond bond rate to be my risk rate what do I have to assume about the government that they will not default right is that safe in some governments do you really think the Venezuelan government will not default but maybe not today but by tomorrow who knows right so what that means is if you have a government where you worry about default you have to start with the government bond rate and clean it up take out the default risk second stop is the equity risk premium the equity risk premium is the price of risk in the equity market and before you even look at the approaches let's put the facts on the table the equity risk premium is a volatile number it changes over time why because it's a I think of equity risk beams as that as that battle between greed and fear that you look at in markets right sometimes greed wins sometimes fear and it can happen it can change over the course of a month take a look at March for the S&P 500 and take look at April for the S&P 500 March was this month where mood was great greed was winning April suddenly out of nowhere fear came back Equity risk premiums vary across time and my you know if you look even at the course during the course of this year my estimate the equity risk for the S&P 500 has moved around and of course if you go across countries Equity risk premiums vary across countries for lots of reasons there countries where and so the the the whole idea of the equity risk premium is it has to be volatile and it has to be company specific now of course the way we're all taught to estimate betas is to run a regression and regression is a terrible way to estimate beta it's a single regression one is purely statistical right when you run a regression you get a slope of the line the slope comes with a standard error it's noising second by definition it's backward looking I can't run a regression with returns for the next 5 years it's got to be returns for The Last 5 Years and third you can game the system I don't know how many of you had a chance to play on the Bloomberg with starting points and ending points just in try different weekly monthly and you get betas that shift around based on the choices you make so as an alternative I said forget about an individual regression beta as the basis for your beta try to get a bottomup beta and if you don't like the way the the bottom up acronym create your own basically you build up to a beta for your Company by starting with the businesses they're in weighting those businesses and multiplying The Weight by the unlevered bait of each business which you get by looking at publicly traded companies in the space but I and where do we get the betas for those publicly traded companies from regressions but the averaging is where you gain so even if you're in a single business you still get that averaging benefit and then you can also reflect changes in the business mix and of course to just for the debt you have as a company you can bring in your company's debt to equity ratio which can be the current debt equity ratio uh change that to it gives you complete flexibility so one of the questions yes go ahead Zach yeah what when you say Diversified in businesses or geographies right they have multiple they're in multiple businesses not like 80% it's 50% 30% 20% what can you speak to a little bit if you were just going off how that would a single regression beta it'll reflect the average business makes you had over the last five years this is if you're lucky and the regression bait is actually a good estimate it'll reflect the so for Disney it'll reflect the mix that they've had between 2018 and 2023 which might be less streaming at the end more streaming so it'll basically try to a everything will be averaged out across your regression period rather than reflecting where the companies today so whenever a company is changing whether it's business mix or it's debt to equity ratio regression beta will if even if it works and it gives you a number that is actually the right number will be a reild reflect the average over the period rather than where you are today so I I can't do this yet for you but as I look through your reports one of the things I'm going to look to see is what you'd run the regression and then you do the alpha the beta and the r squ and then I ask you to come up with the cost of equity and that's where I make the pitch of hey you want to use Bottom ofas now one of these days I'm going to succeed fully on that pitch where everybody's going to use bottomup AAS but there are always these stragglers and you might be one of the stragglers I'll pre-specify what you've given don't go in and try to fix your report right now I'm not going to take points off because used regression beta but I'm going to tell you what the kinds of rationale that I would that I generally see when somebody says I have a regression beta and I have a bottom up beta but I'm going to stay with the regression beta this was in Spring of 2023 last spring 91% used regression beta is I'm sorry 91% use bottomup betas 8% use regression betas and 1% I no no idea what they were doing right it's like they had a gut feeling beta I don't like this beta don't do the gut feeling if you're one of those savants who cons sense the beta for a company I I bow before you but don't show it in this report or show you know reveal it to others but when you look at people who pick a regression beta here are the three reasons I generally see one is my company is unique I cannot find other companies like in a sense every company is unique right but remember betas don't reflect the kind of model or distribution model you have they reflect the business you're in I remember when Facebook and Google first went public and people said there are no online advertising companies you're right but advertising is a business bers reflect how much companies spend on Advertising not how you deliver that advertising before Uber and lift came along there was no ride sharing but car service was a business so even though your company might be unique step back and think about how it makes money and there are no new businesses every business has been around forever the way it's been delivered has changed over time so to the first point of unique just expand your definition of business second is and this is a very common one I'm in only one line of business why do I need to do a bottomup beta remember bottomup betas have the advantage of reflecting the mix of business he's saying if I'm not in a mix but remember you get the law of large numbers that no that that an average beta is better than a single regression beta even in you're a steel company I would still take a bottomup beta from the steel business over your regression beta every single day and finally and this is a very common one my bottom of beta is too different from a regression beta in other words you will use a bottom of beta only if it's close which what's the point right the entire reason for using bottom up betas is precisely because you can get different numbers and when you get different numbers my argument is go with the bottom of beta it is a more reliable indicator so if you picked a regression used any of those three reasons as I said I'm not taking points off for that but hopefully as you think about it say you know what that doesn't make sense so this is the distribution of your betas your regression betas so your regression beta the median is 1.05 the average is one I want you to as I go through the descriptor of your companies start thinking about what the typical company so the typical company that you analyzed was slightly above average risk right that's all the lowest number lowest bait at least according to your inputs was 006 which can happen you have strange things happen to your company remember it's a regression baa strange things happen over the last two or five years you're going to get beta that's really low the highest beta is 3.11 which can happen if you have a very high debt to equity rati and your equities become incredibly volatile so beta measures how risky you are if you trust the regression that that regression slope is the beta then I ask you to computer Jensen's have somebody give me a intuitive explanation Mike Jensen actually just passed away three days ago okay so Jensen what what is Jensen's Alpha measure CLA complete it's better than expected given what its risk and given what the market did right so it's a conditional expectation so the market is down 15% you reflect that if you're a risky stock so it's a risk adjusted Market adjusted measure of performance the average inance Alpha across all stocks is zero and you came pretty close your median company had a gensen alpha of pretty close to zero your average ensen Alpha was positive which tells you that it C across your companies you more likely to pick winners rather than losers none of you went looking for Bed Bath and Beyond a lot of you went looking for Nova no disk and Nvidia we tend to again this is a feature is when you want to analyze a company you'd much rather analyze a winner than a loser and that can be a problem the way we think about businesses right we take the winners we celebrate them we learn from the winners but we can also learn from the losers but there isn't enough attention paid to them so we pay attention to Uber but we don't think about the fact that a taxi cab medallion was the way car service was delivered 20 years ago and that business has collapsed and you're r squared and again this is where I had to go and remove the 363,000 because the way I knew there was a problem is the average R squar came in at like 183% and I said I've got either relearn statistics or something is going on your median R squar is about 32% which is I think pretty reasonable a third of the risk in a typical stock comes from the market 2/3 is company specific specific now you can see why managers get uncomfortable using betas right if you're a manager in a company you think about all risk and we're we're kind of arguing that you should focus only on the risk that is macro Market risk but the rest of you screaming but what about all of the other risk and the argument is not that it doesn't affect value it can show up as an expected cash flow but it's not going to go into your denominator because investors can diversify away the risk so that's the cost of equity component you get it either from a regression beta or hopefully from a bottom of beta your Equity risk premium should reflect the geographic mix of where you operate so when I looked at your Equity risk premiums I don't think there were two Equity risk premiums that matched up and you should expect that right because even if you're a US company there are very few companies which get all of their revenues domestically and some of you spent I think way too much time finessing that Geographic because your company frustrated you right they said 71% from the US 18% from Europe 11% the rest of the world and you said what is the rest of the world I want to find out what the rest of the world you probably spent six hours on Google search looking to see where Starbucks were in the rest of the world you got that out of your system don't ever do it again if you have 11% of the rest of the world just use the global Equity risk for that 11% remember ultimately the effect is what will do to your cost of equity yeah yeah oh that every every step you could have right part of it only comes from doing it right so I could have told you won make any difference in your cost of capital but sometimes you have to go through the six hours finesse it and say I could have got pretty much the same number if I used to Global Equity risk premum one reason I kind of restrain myself from stepping in there is the second the when you learn it yourself it sticks right so that's part of it the other is we live in a world we have too much information none of us should be complaining I can't find stuff anymore it's the rabbit holes happen when you you go looking without knowing what you're looking for never open up Google search unless you have the question you're trying to find the answer for don't you have a company I'm going to go on Google search you are going to go into rabbit holes forget about rabbit holes you're going to be another planet before you know it because you're going to get pulled out of your comfort zone but if you think about cost of capital you got the cost of equity which reflects the risk free rate where so it reflects the business mix you have and the geographic mix and the currency Choice and then you get to your cost of debt once you made the currency choice and your cost of equity your cost of debt has to be in the same currency this is not about what currencies you borrow in it's currency choice in analysis is just like a measurement variable Fahrenheit versus Celsius you make a choice you stick with it the cost of debt you start with a risk free rate the same risk-free rate that you start the cost of equity with and you added default spread for some of you that choice was easy because SNP or moody or Fitch did the default risk assessment you came up with the rating for some of you you had to assessor rating yourself for some companies you assess both and they did not match up for an obvious reason you know the synthetic rating that we compute is based on one ratio interest coverage ratio it has no Nuance it doesn't consider all the rest of the stuff you would expect the S&P and Moody's rating to be more informative because they've looked at more stuff so we have both an actual inance synthetic rating my advice is don't look for trouble just go with the actual rating just be aware of that difference because it's going to come back when you do the optimal debt ratio and become an issue perhaps in why your optimal might give you a number that doesn't make sense so you come up the cost of debt remember though that you need an after tax cost of debt and for that after tax cost of debt you need a tax rate remind me again what tax rate I use a marginal tax rate give me the reason because you're going to get into argument somewhere along the way the summer next year why do we use marginal tax rates I want what is it that we're trying to capture the tax benefit from interest expenses right how does that work Gand it's not that it's B you subtract it from your total income so if you think about where you get the you have 1.1 million income you have 100,000 interest expenses you subtract the 100,000 to report taxable income it's the last 100,000 on which you saved on taxes so it's not that the effective tax rate can't be different from the marginal tax rate it's a fact so both in the lever Beta And in the cost of debt use the marginal tax rate where do you get that marginal tax rate you look at the country in which you operate if you're a multinational I'd still probably look at the country I operate because you don't have to borrow in every country that you operate in you can choose where you borrow Apple borrows all its money in the US why with the 25% tax rate they don't want to go around the world trying to you know borrow money in countries we get a much lower tax benefit and for the weights use market value weights market value of equity is easy right for a publicly traded company market value of debt is messy why because even companies that borrow issuing bonds those bonds are not often traded you can't look up a market price and even those companies often have Bank debt that's not trade the book Debt is often what you have and for most companies using the book dead as if it were market and be very clear when you use the book Dead you're not using it because it's book because you think it's pretty close to Market is not going to get into trouble but there are two places or two conditions where the book Debt can and be misleading what are the two play conditions where book Debt and Market debt can deviate one is distress companies because when you look at book Debt it reflects what you borrowed but distress company the cost of debt has gone up so and the other is if you borrowed money in 2021 and that debt is still on your books why because interest rates were much lower and now that they become higher the mark so it's better to do Market debt but again on this project you said book Debt I think my company's healthy I'm going to use book de as Market Deb I'm going to back off and say okay this is again a detail I don't know it's not worth finessing and especially when you see how much or how little debt your companies have G for the maturity not for the debt for the maturity because then the book Debt will become the market debt right because when you compute the present value if I have debt that's coming due the book and the market debt will converge exactly yeah so let's start by looking how much debt you have and this is again as you know when you think about know Zach pointed out rabbit holes many of you spent a lot of time trying to get the cost of debt right to the second decimal point but here's the reason it doesn't make much of a difference these are the debt ratios the actual debt ratio the companies take a look at how many companies are debt ratios less than 10% in fact many of these companies if you didn't capitalize leases would have no debt at all it's not uncommon for companies to not borrow money that's hopefully one perspective you'll take out of the classes when you see a company with no debt you're saying where is it hidden there is no debt they haven't hidden it away from you they just don't borrow money and if you look at the median debt ratio across your companies it's about 17 a half% next time you listen to some guy on CNBC talk about how us companies have gone on a borrowing SP spring people just make up crap I mean us companies if you look at you know whether you look at debt to Capital or debt to Abida have look you know in fact they look healthier now than they did 20 years ago so if you're going to make an argument about us companies doing unhealthy stuff at least based it on facts you can see that in the companies you pick there is one company though and and I'm curious how it made it into the moneymaking criteria which had 95% debt I think I know what the companies and I think it's actually pretty close to the actual debt ratio shows you how high the debt ratio can go before you tip over the edge so that's your cost of capital it reflects not just your overall cost of funding it's your opportunity cost looking across the whole company and then I said what kind of projects does company and this is a really difficult question to answer why we don't have insight into individual projects Disney doesn't invite you and say take a look at our theme park numbers right we're looking at a company from the outside and what you're getting are is the income on their portfolio of projects some of them might break it down by business but they're the exception rather than the rule so we look at accounting returns and we hold our noses while we do it and many of you notice as you computer accounting returns that strange things happen if you step back and think about in a in a in a in a world where accounting earnings actually made sense and accounting book value actually made sense there are two ways you can compute returns one is you can look at returns with the eyes of equity investors net income divided by book Equity that's return and Equity the other is to look at after tax operating income income to all invest in the firm and divide by invested Capital invested capital is book Equity Plus book Debt minus cash this is the only place in finance we go back to book value everywhere else market value what are we trying to do we're trying to answer the question are the existing projects for this company good or bad projects so tell me some of the issues you ran into in terms of computing accounting returns yes yeah so that lowered income but what did it do to your returns it made so the earnings became negative because depreciation amotization that can happen right accountants can take big charges you have a restructuring charge no yes right and in fact it drives it down not just low but how many of it NE had negative book equities and it freaked you out right because you what does that even mean the accountant is telling me my company's worth minus5 billion tells you why balance sheets matter less and less because you can have I mean Apple's Book value of equity is going to become negative in a few weeks you know why because they're buying back $110 billion worth of stock and when you buy back stock it effectively lowers your book Equity disproportionately because the market value Equity is so much higher clear not meaningful right you can compute an Roe it's going to be negative but it's because you have a positive numerator and negative denominator right if you then conclude that company's taking bad projects it doesn't really make sense it's a numerator that's a good thing it's a denominator that's that's that's causing it can the investor did any of you have negative invested Capital do you have a negative invested capital it's more Uncommon but it can happen book Equity plus debt minus cash Apple will you know again it's going to have negative invested Capital because not only is its book Equity going to drop it still has $150 billion cash balance you saying what do I do there just throw return and equity and return invested Capital out it's you saying then how do I judge projects I mean this is just one piece of a much bigger puzzle right if I ask you is apple picking good projects what's your sense as has has Apple picked good projects over the last 20 years yeah do we need an Roe and roic to no Warner Brothers Pick good projects again I don't need an Roe and roic said this company is in trouble it's big crappy projects so sometimes getting that picture of the company and recognizing it's nice to have a return equity and return inv gives you a peeg but even without the peeg you know in fact the followup question I asked you to to consider is not just what the return invested Capital return Equity are but what do you think about the future because remember when you earn more than your cost of equity or cost of capital you have some barriers to entry competitive advantages are those going to last and with apple I think there's an interesting question almost all of that high return equity and return invested Capital comes from one investment Apple made 20 years ago which is the iPhone right the iPhone is the beast that's carried Apple to a$3 trillion value is there more return left in the iPhone I'm not sure I mean iPhone I have an iPhone 12 I'm not even tempted by the iPhone 15 what are they going to do 17 cameras in the back I can't take a selfie with S I can't take a selfie at all adding 15 more cameras will just make me even more confused about what exactly I'm seeing on my camera there is a question with apple and you see the market starting to ask it is this it now Apple might surprise you and come back but maybe it won't and that's the assessment that really matters because it leads you into the capital structure dividend policy and valuation so I'm going to know report back your return spreads remember I asked you to compared return ver Capital cost of capital with the caveat that accounting returns are these noisy numbers your typical company had a median return spread of 5.22% and your average was 21.6% there were some outliers remember I we saw this across all global companies do you remember what percentage of global companies what's the median excess return for a global company a positive number or a negative number 60% actually 69% of global companies earn less than their cost of capital your sample is clearly different in your sample about 61% of companies earn more than their cost of capital what what what do you think caused this one is your search for winners what else some there was a Criterion I added when I listed when you pick projects up front that some of you chose to ignore and live to mour which is don't pick money losing company compies and don't pick Banks I might be repeating myself but it's the same thing right Banks and money losing companies I essentially took a lot of the negative excess returns out of the picture so I'm not surprised so we've got the investment return section then asked you what's your optimal debt ratio and it's true the the spreadsheet kind of got in the way because it kind of came up with the number but if you look at the at at your optim so now this is the optimal if you remember the actual ual debt ratio graph it was all bundled around the 10% going down your optimal you know 30% was the most there were there there were a couple of companies and now you know which had optimal debt ratios of 90% can it happen yes your market value has collapsed you have a lot of cash flows to service the debt but you can see that there's a bundling between 20 and 40% of the optimal debt ratios there are 18 companies with an optimal debt rati of 0% six of them with those money losing companies and that's part of the reason I beged you please don't pick a money losing company because after you finish the investment act after you do the cost of capital the rest of the project writes itself right because what's your accounting return going to be if you have if you're money losing it's going to be negative how much can you borrow if you have no if you're money losing it's zero how much can you pay in dividends for your money losing nothing maybe you can come back to life in the valuation section so it requires incredibly creative reasoning to write something interesting for Capital struction dividend policy now but the the other 12 were not money losing companies this were had very low income they were M money making but the market value was huge remember the first debt ratio I try is a 10% optimal if you're in video at 10 10% of 2 trillion is $200 billion right you're already going to be tipping over the edge so remember these are market cap debt ratios and that can factor into why your optimal is Sol low Justin yeah I also looked at you because you had the actual an optimal for the companies I wanted to see whether the typical what the where the typical company and your typical companies under 11 the average about 11 so basically I'm just saying the actual debt rati the optimal you had 121 underlever companies and 72 over levered companies again if you're going to have a prom it's better to have the underived prom but it's not that's not something you can pick on the Deb matching I steered you away from running that macro regression and of course you ran it and got good results all the more power to you because it's incredibly noisy know the macro regression I'm talking about we run you take the firm value run against change in inflation interest rates it's of nothing else a neat little exercise but you get strange looking output right so so you can't but I would you know you're saying what do I do that remember there is a much more powerful in my view in way of thinking about whether your company is the right kind of debt Because by the time you get to this section you should have a sense of you know what a typical project looks like and that's part of the reason I asked you what does a typical project for your company look like for some companies it's an easy question to answer Home Depot for other companies it's more difficult what's a typical project for Disney it could be a movie it could be a addition to a theme park much Messier but your debt should match up what a typical project looks like in terms of duration in terms of currency whether your pricing power so in this debt section you're basically asking what is the right kind of debt to what purpose you can compare to the actual debt then and the debt is mismatched you're creating default risk that you can be avoiding and you should try to get that mismatch out of the way so we finish capital structure we get to Dividend policy right you see what the company's paying out you can pay dividends but increasingly in the US you also get BuyBacks and I said you need to compare that to what your company could have paid out in dividends we called it free cash Road Equity but I actually think potential dividend is a more powerful way to describe it free cash Road Equity sounds fancy potential dividends this is what you could have returned and the way we measure potential dividends comes entirely from the statement of cash flows you start with the net income you add back depreciation you subtract change in working capital all in the operating SE so in the first section then you move to the investing section and you selectively pick the investing that actually goes into operations capex Acquisitions you don't put in investments in financial Assets in there because that's where the Free Cash Road Equity goes and then in the financing section you look at debt coming in that's a cash INF flow and debt repaid which is cash outf flow you end up with potential dividends that potential dividend could be negative as I was looking across your 193 companies I think 21 had negative free cashlo Equity does that mean they can't borrow money if it was just one year you can get away with it but if you have negative free cash flow Equity year after year this company should be returning cash so first thing I asked was what percentage of cash return in your companies and you gave me the numbers came from BuyBacks across your companies the median percentage that came from BuyBacks was 63% so you're getting pretty much what we saw in terms of that trend line most of your companies if you look at how they return cash returned it in the form of BuyBacks there were so there were you know about 20 companies which had only dividends and the Other Extreme there were about 46 companies that were all BuyBacks I'll wager and this is a graph I've had over time and that all BuyBacks grows every year all dividends decreases every year I'll wage it 10 years from now if you have this graph the all dividends will be even lower the all BuyBacks will be even higher because it is a more flexible way of returning cash and then I compared how much cash you said your company returned to the free cash R according and the I know it's a little confusing in there say it said over the latest periods and he saying why doesn't he specify the periods because for each compan each of your companies then the answer is different for some of your companies you 10 years of data for some three years of data this is the aggregated cash return to the and for your median company that ratio was about 88% so your median company returns about 88% of its free cash Road Equity with a huge amount of variation across companies if you can see the average 200% means there are some companies that are returning eight to 10 times the free cash load Equity huge outliers you got almost an even breakdown in 97% 97 of your companies your cash return was was less than your free cash R Equity so what are these companies doing when they're returning Less in the free cash Ro Equity to their cash balances no it's not reinvesting remember free cash Ro Equity is already after reinvestment it's just going to the cash balance so 97 of the companies the cash balance went up 96 the cash balance went down something to keep in mind when you see rising and falling cash balances I know we did valuation at the very end so I'm going to cut you a lot of slack on the valuation because clearly you did it in the last two three four days but if you step back and think about valuation there are two ways you can approach valuation you can take cash flows to equity dividends if you want project them out discount them back at the cost of equity and come up with the value of equity or you can take cash flows of firm which are pre debt cash flows discount them back at the cost of capital and come up with the value of the F now there's a there's a loose are some loose sense when you do free cash Ro equity and free cash Ro The Firm valuation that I just want to very briefly talk about the spreadsheet did it for you but I want to talk about what exactly happened in that black box when you take dividends and discount them at the cost of equ you're done what you get as a present value is the value per but when you take free cash Lo Equity of free cash to the firm and discount them back there's some cleaning up to do when you value free cash flow Equity the cost of equity especially if you've not counted in interest income from cash you still have to add cash and if there are options in the company you got to subtract out the options you gave away to management but when you value free cash with the firm at the cost of capital there's a host of cleaning up you got to do because remember when with free cash with the firm your measure of earnings is operating earnings ebit so put simply any asset whose income is not part of bit has not been valued yet the case of Apple the 150 billion cash has hasn't been valued yet because interest income from cash shows up below the operating income line if you're T motus those cross Holdings you have in other Tata companies haven't been valued yet because the income from those cross Holdings shows up below so not only do you have to add cash you have to add these cross Holdings because they haven't been valued yet and then you subtract out debt and if you have Equity options management options you've given you got to subtract them out until 20 7 uh I think 2007 or 2008 the bulk of stock-based compensation took the form of options today the bulk of stock-based compensation takes the form of restricted stock units and if somebody does valuation I get on me say thank you God it's much easier to deal with restricted stock units just add them to the shares outstanding options are a bit of a nightmare they're neither here nor there right they could be in the money out of the money so that's why we bring option pricing models to Value those options and net them out because there're a piece of your Equity you've given away so I want to a few pages in valuation I never got to so let me let me hit I talked about valuing do with the dividend discount model it's a simplest of all models to use and you can see why you focus just on dividends growth in dividends and you discount them back at the cost of equate in 2008 if you remember the growth rate I gave deutch's earnings given their return equity and retention ratio is about 5.4% and I felt pretty comfortable middle single digits I didn't see the crisis coming so you see my projected net income for the next five years I left the payout ratio at 54% because that went into my growth rate I get expected dividends for the next five years we'll talk about what happens after five years I take the present value of the dividends at the cost of equity The 9.23% Sounds looks familiar it's how we comp it's a bottom up cost of equity for do but at the end of five years the world doesn't end right the company goes on but what I've assumed after the fifth year is this company is going to be in steady state in stable growth why do I need to do that because I need closure so after the fifth year I'm going to assume a 3% growth in perpetuity which in 2007 was eminently reasonable because the risk free rate in Euros was 4% but when I lower the growth rate from 5.4 4% to 3% my payout ratio has to change as well right that's a critical component when you do valuation is when you get to steady state you lower the growth rate you got to give the company the characteristics of a mature Growth Company so two adjustments I made one is I adjusted the payout ratio upwards because their growth is lower I said they can afford to pay out more and the way I comput it what their pay out ratio can be is by assuming that after year five that they would earn their cost of equity which turned out in hindsight to be a hopelessly overoptimistic consumption but that is hindsight so they can pay out more I also assume that as a mature company the cost of equity would go down to8 and a half per. so they become safer as a company as a mature company and they have a higher payout ratio my terminal value the the value at the end of five years is I take the dividends in year six and discount them as a perpetuity with an 88.5% cost of equity so of two different cost of equities floating around one for the first five years and one after year five there's one final loose end year right that value that I'm getting is the terminal values at the end of your five I want the value today so I discount it back and I want you to notice what the cost of equity I'm using to discounted back it's not the 88.5% but you're going to see this on the final exams as well when you get to the valuation question you have two different costs of equity you use the terminal cost of equity to get the ter value but to discount it back to today why do I do that why why know what's so logic in using the cost of equity for the first five years that's the cost of equity you got to live through the next five years to get to the terminal value right if you're really risky firm that present value has to reflect the risk through the period that I've got to live through add them up I get a value per share of 10488 stock was trading at 89 thank God I didn't buy the stock stock I was I should have been tempted but I kind of left it alone know the stock went down to seven it's I don't think it's exceeded $20 20 EUR in the last 10 years so you can see how much the stock has dropped off the cliff on Disney I had a Messier problem right if you remember this was a 2013 valuation and as I do it I want you to think about what would be different if you valuing Disney in 2024 Disney 2013 was coming off a pretty successful time period excess returns were positive Jensen's Alpha was positive so in val Disney I created two periods so in the case of deut I had only one period right five five years and then St here I created an initial period where I kept things at the status quo let me explain I assume that Disney at that time Bob AA was firmly as sconed as CEO would continue to be run the way it had been run historically so I took its existing return on Capital if you remember the 12.61% comes from session 14 or 15 the historical return on Capital their reinvestment rate from the most recent year and I assume they would keep doing that for the next five years my expected growth is 6.8% the product of the reinvestment rate in the return capital for the cost of capital I left the cost of capital at the existing debt ratio the reason I emphasize that is when we did the optimal remember we came up with a much lower lower cost of capital I've left it at the existing because I don't run the company Bob arer does and since he doesn't seem to feel any urgency to borrow money this is something I see analyst to use a Target debt rati value company don't do it unless it's your company you can't step in and replace an actual because you feel the company can to borrow more money I think eventually pressure will build up on Disney to borrow so over time that cost of capital decreases from 7.81 to 7.29% not much of a change because it's a pretty mature for already this transition phase think of it as an unknown I didn't know that but in year 11 I assumed the company would become a mature company so I brought the growth rate down to a mature growth rate but everything else also changed the cost of capital change the reinvestment rate change the return on Capital change and effectively in year 11 I'm making a Disney a mature company with lower returns and capital lower investment rate and a lower cost of capital saying what about the transition period it's automated my growth rate for the first 5 years is 6.8% my growth rate after year 10 is 2 and a half% all I do in the year 6 7 8 9 and 10 is go from 6.8 to 2.5 in linear steps don't finesse this it's not worth it same thing with the cost of capital every number that transition period is to just to get it from where it is today to where it is now so that terminal value is a big number but there are four things you can do to keep it from running away from you one is remember I said you could use this equation only if your growth rate is a growth rate you can sustain forever and I said that growth rate cannot exceed the growth rate of the economy respect that cap you'll be tempted because you want to make the value higher say can I make it a little bit higher that's it's like being a little bit pregnant I don't think it works you're either breaking the rule or you're not this is one of those things where if you mess with it's easy to start tweaking it and tweaking it and the next thing you know you value you've lost control of the valuation respect the cap second remember this is Disney 10 years from now not Disney today it's Nvidia 10 years from now not Nvidia today the returns and capital they will have then will be very different you saying how the heck am I going to know what it is it tell you know you have to tell a story about the company whether it can maintain its competitive advantages over time so you have to think about what your return on Capital will be in this case I did assume that that return Capital would drift down from 12.61% to 10% as Disney got bigger entertainment gets more comparative you have to reinvest to grow just because you're a stable company doesn't mean you can stop reinvesting and for you that number actually pops out from the first two if you respected the cap and I did by setting the growth rate at 2 and a half% and then I said the return return on capital is 10% in perpetuity your reinvestment rate comes out of those two assumptions remember growth is equal to re so when you get to terminal value that sustainable growth equation tells you what the reinvestment is going to be and finally the cost of capital for Disney in year 10 will be different from the cost of capital one of the things I find troubling when I see people doing DCFS in practice is how they get one cost of capital and it stays Frozen at that number in perpetuity that's inconsistent with what you're telling me about your own company in your own spreadsheet your cost of capital should change for most companies over time so here's my Disney valuation based on that input and the story I've told you so it's a story of the status quo a relatively well-run company continuing to do what it does and you see that play out in the so every number in this valuation comes from something we did in the class why is the cost to cap where it is that beta is the bottom up beta that we use from the five businesses the equity risk premium reflects the geographic mix the risk-free rate is in US dollars because I chose to Value Disney in US Dollars the default spread comes from their actual rating the marginal tax rate of 36.1% is the marginal tax rate we've used all the way through the mix of debt and Equity is a market value mix Equity is the market cap the Deb includes in 2013 my estimate of the least debt plus the rest of the debt in market value terms so that's my cost of capital to begin with over time it declines my cash flows come from my expectations of growth 6.8% and my reinvestment so the reinvestment is the Consolidated effect of net capex working capital Acquisitions all the stuff Disney might do over the next 10 years at the end of 10 years I put the company into stable growth 2.5% or 2.75% growth in perpetuity and that terminal value of 165 billion is the elephant in the room that's the big number to driving my valuation and it'll always be a big number in a discounted cash flow valuation discount back all of those numbers today I get a value present value of 125.5 billion with the operating assets I add cash he's saying what non-operating investment this was the 49% stay Disney was not allowed to own a controlling stake of Hong Kong Disney one of the requirements of the Chinese government was that Disney would actually have to settle for 49% the Chinese government owns 51% that 49% is not treated as part of the operating assets it's a separate almost like a joint venture so that's the 2.8 billion I subtract our debt and there's a minority interest there's other stuff that they've Consolidated a TV station or TV company in India so all those things that they control this is the portion that doesn't belong to them I get a value for the equity of about this tiny slice of options not a big it's not a tech company giving out options like they're going out of St the value per share that I got and this was in November of 2013 was $63 you know last year this he came very close to that 60 and that is 10 years later in a market that tripled that's kind of a scary thought so if you look at the last 10 years Disney's gone nowhere it's kind of run in place it had rise it's fallen off and that's part of the reason there's so much angst about where is Disney going so I asked you to Value the company and I will take the numbers with a grain of salt because it happened in the end you really had didn't have a chance to think about your story so you know but based on what you gave me the median company is over overv valued by about 8.7% the average company is overvalued by about 90% but again that's because there were companies that you found overvalued by 300 400% right the median companies overvalued and 74 of your 193 companies were undervalued 119 were overvalued that ratio I track over time because it tells you the collective optimism or pessimism about the market and what's happening around you so now that value reflects the existing management running the company right now what's Nelson pels is argumented Disney could be run differently right whether he's right or not I think people are open to that question especially after the last few years so when you think about changing value boil it down to Basics mean one way of thinking of changing value is can I do something to improve my cash flows from existing assets that's the first stop if you're running existing assets inefficiently maybe you can extract more cash flows second stop you look at growth and ask a fundamental question should I even be growing you saying what what's wrong with growth if you're growing and earning less than the cost of capital I'd prefer you not grow if you're growing and earning more than your cost of capital I might ask hey could you reinvest more are other geographies other products then you look at the cost of capital and the cost of capital you can see that you know if you change the debt ratio you change the type of debt you match the that up you might lower the cost of capital and perhaps if you're really good about building up your competitive advantages you can put off the time when you become a mature company to me that's what corporate strategy is all about is building up that period where you can earn more than the cost of capital so when you go into a company you're saying is there something I can do to change the value of the company right now if I've made you CEO of Invidia you what why you making me come in here what can I do here this company looks like it's pretty close to perfectly run you put those on the table there are no perfectly run companies there's some very well-run companies but every company as a blind spot maybe there's a little bit of Deb capacity that Nvidia can use that you might come up with but the reality is you're not going to be able to move the value of Invidia very much but right now I'm sure if you if you looked at Disney the things you might say I would do things differently so with Disney here's what I did I said okay I'm at the point where I looked at Disney and this was in 20133 and there are a couple of things I think they can do differently one is I think they can use more debt this is the place to bring in your optimal debt ratio and the fact that the cost of capital will be lower I said maybe they can go to a low higher debt ratio low as the cost of capital on the investment side I do think that if they're more selective I think they're they they need to reinvest less and be more selective selective in what sense the best investments Disney has made in the last 15 years has been buying franchises that other people have kind of let go to waste think of Marvel and I'm thinking about you know Star Wars much as we love George Lucas and Star Wars was BEC almost you know at a point where his views were kind of driving out what you could actually do with it and I'm sure if you're a Star Wars fan you're ready to fight me on this one okay but the truth is those those are two franchise they got for four bill billion Each of which they probably got quadruple the value what's the worst thing they did well buying for you know SE spending 70 billion for those newcorp assets when they wanted control of Hulu which was a silly thing to do because you're spending a lot of money so I did lower the reinvestment rate and raise the return Capital not by a huge amount they used to earn a 14 15% return on Capital it's drifted down to 12.6% I said with those changes I get a slightly higher growth rate from 6.8 to 7% but they I deliver it more efficiently with those two changes put in the value that I get is 7491 the value that I got with the original 6256 the value I'm getting with the changes put in is 7481 what what should I call that difference they're worth $64 $65 with the status quo I think if it's run differently it can be worth 75 it's about a $10 difference that's the value of control I know that Bankers put a 20% premium the value of control is the difference between two values the status quo value and the value of the company run better but to answer the second question you need to understand Corporate Finance I remember when Carl Ian in 2013 took an activist position in apple and his point was Apple should borrow $300 billion it'll make the company more value valuable which was stupid cuz if Apple borrowed $300 billion they had go to Triple C but he actually assumed they could borrow 300 billion at the prevailing interest rate that they were borrowing money at this is the kind of mixup that happens when you don't understand I mean I think that if you understand Corporate Finance you're going to get much better at valuation because you don't make these changes and not think through what the heck does that mean when I raise my debt raise show it makes my Equity riskier my debt riskier what does it do to the cost of capital but I think that effectively is where Corporate Finance comes it now as you went through the project at each phase you were telling me something about your company right when I when you got to The Leverage question asked you is your company under lever then you got to the dividend section is it accumulating cash you got to the valuation section is it undervalued I have a triple wamy list these are the companies you you you analyzed which were under levered undervalued and they accumulating cash as an invest as an acquirer do you see why these companies look attractive to you because you got one of if one of those three things work for you I'm not suggesting these companies are all going to be acquired but they have the pieces in place that if somebody acquire because remember the best place to be in investing is to be the shareholder in a Target firm when it's targeted for an acquisition not after but before so if you are creating a preemptive portfolio of saying look you know I'm going to take positions I mean you might have an ESG problem with Smith and Wesson but that's between you and Smith and Wesson right but these are the companies that for again Bas analysis looks like they have all three pieces in place so you've seen this page before and might as well see it again so in the first set how many times you've seen the same page over and over right hopefully by now it has a little more heft to it investment principles says go out and take Investments that earn a return that is greater than your minimum acceptable hurdle rate hopefully by now that minimum acceptable hurdle rate has something backing it up we measure risk with ative investors are Diversified the cost of debt with default risk and the mix is captured in the weights we put in the cost of capital for you know whether the returns are high you you could already see why if you have cash flows you don't want to go with accounting earnings after especially after entanglements with return on Capital and return on Equity the financing mix say go ahead and find a mix of debt Equity that minimizes your hurdle rate and after dealing with that you could see it's not a slam dunk more debt doesn't always make your cost to Capital lower even though it's cheaper than equity and match the debt up to your assets the dividend principle says if you cannot find Investments that earn your hurdle rate and even with within this class remember 40% of your companies are earning less than the cost of capital for those companies they're accumulating cash as as a shareholder you're going to start with a position of skepticism which is why should I trust you with my money and cash return is basically a way of extracting cash out of a company which no longer has the Investments to take with that money and the fact that Google and Facebook have kind of jumped the process and we're going to start paying dividends suggest that they're aware of the problem as well that you and they and and that's a healthy place to be when companies and shareholders are both on the same page so if you remember at the start of this class I did say I had three objectives for the class I'll go back and revisit those objectives though I might be ripping off scabs on wounds when I do it the first I said this is a class where I want you to think about the big picture what does that mean as you get caught up in that Equity risk premium graphic mix now I call this elevation you step back and say where does that fit in the process the first time you do it it's almost impossible to do you're going to get into every ditch and stay in that ditch and spend days in the ditch and you come out and say why did I waste my time in the ditch it's not a waste because each time you do it you will get some perspective on where to spend your time the next time around the second is this was an applied class I don't think I introduced a single concept which I did not try to apply I mean but when you apply things you got to be pragmatic you if you're a purist and you come from a you know the theory vision of this is what I need and I will not do it you will never apply things because there will always be things in the real world that go against you and I want to ask you do you have fun because this is not the right time to ask that question because clearly this weekend you did not have fun right but here's what I want you to think about two months from now four months from now when you read a new story I mean I call these aha Insight moments where you read and say I see what's going on here build on that because that's really what's going to keep I mean I my valuation class I mentioned this deoderant bot that vandar has developed that 20 people in the valuation class are doing valuations and the demod bot which has read every blog post I've ever written and looked at every valuation I've ever done it's going to Value the same company and it's a contest to see how close AI is each of you has a bot out there it's coming for you and your job is to stay ahead of the bot if what you do is mechanical you're done your Bot will beat you why because who can keep you know I have 2,500 pages in my blog who can read 2,500 pages and remember it all the bot can I've there are probably 250 valuations I've done that in the public domain you could look at all 250 spreadsheets but your brain's going to be swimming but the bot can look at that if your strength is I'm I know how to look through financial statements Let It Go I mean this is not a strength anymore what you're looking for is something you do that your Bot will not be able to do I would love to tell you I have the answer I'm terrified of how this demod board is going to do if it does really well I'm saying what's the point let it write the blog why am I writing the blog it remembers everything I've written if it does really badly I have a different prom I write my blog I do my valuations because I want to teach people how to Value companies I'm thinking what can what do I do that is going to be difficult for that bot to be able to do now close today with the with a story and this is basically you know I'm not suggesting I found the Magic Bullet but about eight weeks ago or maybe two three months ago it's been a while uh I get an email from somebody in Iceland who read my blog and he sent a question he said I'm valuing a company called Blue Lagoon it's a spa in Iceland it's been around a long time history of making money and he said I'm facing a problem there's a volcano that's erupting and the lava is flowing in the direction of the Blue Lagoon how do I bring in lava flows into evaluation right I've looked on Google search how do you bring lava flows nobody's done this before so I read the email but I had to walk the dog the dog was getting restless so I walk by the beach and as I'm walking I think about another story I'd read about 23 and me you heard of 23 in me now what do you send saliva blood your firstborn something you send send it to them and they tell you something about your genetic makeup or you know makeup or they make up something we have no way of knowing it and if you been reading the news a few months ago 23 and me had a problem somebody hacked into their computer and got the data on all the genetic stuff that 7 million customers catastrophic if you think about it and then as I kept walking I thought about the fact that I was I live in a house in La Hoya two blocks from the ocean on one of the biggest earthquake Falls in California and I paid $2 and5 million for this house saying what do the three things have to do with they're all about catastrophes right and how we as human beings try to bring it in and the last one just said no here I am paying $2.5 million for a house that can be in a hole in the ground or a tsunami or under a tsunami any anytime soon and I didn't build it in so it was three mile walk nothing else to do I let the ideas clad around and when I got back I wrote a piece on catastrophes with these three very diverse stories kind of playing out of this is what I think about catastrophes this is why as human beings were bad at building catastrophes and if you have a catastrophic scenario you don't think about the financial implications the example I gave in the blog post is when you watch Mad Max Thunderdome how many times do people check their portfolios in the movie in an apocalyptic movie do you ever in an apocal okay there you go yeah but basically in an apocalyptic movie your first instinct is survival right so if I tell you 20% of the world that you're going to be in a catastrophe you don't build that into your valuation of Invidia today you don't care that 20% it's not so I think as human beings we take catastrophic events out of the process not because we're being irrational but if we brought them in we'd never sleep if every night oh my God an earthquake could come or a tsunami could come I would drive myself crazy but my point is those those are three very different stories but is human beings that's the strength we have but it's it's something we're losing because you know before Google search came along this is the only way you could connect things right you basically I think we're getting you know we're losing that as it gets easier and easier to look up answers so my advice to you is the next time you have a question don't be in a rush to get to Google search and check out the answer see you know see if you can reason your way don't do it if you if you're looking for the location of a restaurant you can't reason your way there use Google Maps then and get get it done with but I'm thinking about some question about taxes or tax policy or where the Market's going don't be in a hurry to let somebody else's thoughts intrude in there so I'm going to leave you with that because know it's uh I will see some of you in my valuation class I teach only in the spring why because I don't like being in New York much of the year so I don't want to be in a hot humid summer so I'll leave on May 16th I have my plans all set out so that's why exam comes in I'm going to grade it I'm going to get it back to you and I'm out of your May 16th and I'll be back around January 22nd 23rd of next year in the meantime what I'm going to do probably walk my dog I mean this is a good excuse for me not to work right because you got to keep an empty mind for this basic stuff to happen so I will see you at the exam and um you know and when you do send in your projects please CC everybody in the group now that way when I reply I can reply to all you all get your graded project back so hopefully I can start on the projects this evening I'm going to start the valuation projects first not because I prefer the class but they're more seniors in the class they need to get out of here and I don't think they're lying awake saying will I fail the class but still it's good to know you did not fail the class and then I'll move to corporate finance so sooner or later you should be getting the projects back thank you oh one more thing you do you do know there is a CFA and I have a very selfish reason for asking you to fill out your CFS if you don't fill out your CFS guess what happens you can't check your grade and if you can't check your grade I know exactly what's going to happen next you're going to email me and say I can't check my grade can you tell me my grade by then I'll be in San Diego walking my dog so please do your CFS get them out of the way no thank you just just that's okay