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Goldman Sachs vs. The Professor

Jack Bloom | May 17, 2016


Goldman Sachs (GS) promotes a list of stocks to buy. They call this list their conviction buy list (CL) – in other words buy these stocks. Goldman believes they will outperform the market and that you should let them manage your money. Should you believe them?

I had the pleasure of communicating with one of today’s greatest teachers of finance, NYU Stern’s Professor of Finance, Aswath Damodaran. He teaches corporate finance and equity valuation at NYU.

Professor Damodaran has been named one of the top 12 U.S. business school professors and has received teaching awards from NYU and University of California, Berkley. He is clear, thoughtful, balanced and thorough.

My goal was to get a concise understanding of his views of the market.

Does he believe that you (or your adviser) should be making individual stock decisions regularly (the way Goldman suggests)? No, the market is very good at pricing the value of a business.

Does he believe that sometimes you should develop your own ideas and invest according to your own views when they are very strong? Yes.

The answers on how and why to do this are below.

Professor Damodaran, what are the 3 most important things we know about finance?

  • That the risk in an investment is best measured by what the risk that it adds to your portfolio (modern portfolio theory).
  • That human beings continue to be human beings (with all their quirks) when they run companies and invest in them (behavioral finance).
  • That the value of a business is driven by its investment, financing and dividend decisions but that the price is set by demand and supply (value versus price).

On balance, do you believe in the efficient market theory?

  • Yes, in the sense that beating the market continues to be incredibly hard, even for the smartest people.
  • No, in the sense that markets don’t make big mistakes for long period.

Is this a good summary of efficient markets?

  • Managers convey information honestly and in a timely manner to financial markets, and financial markets make reasoned judgments about the effects of this information on true value.
  • But there is a much lower bar as well. A market is efficient if you cannot find a way to beat it consistently without breaking laws or rules.

Can you explain in as much detail as possible the actual process of human decision making which makes the markets rational or efficient? A lot of people find this confusing. For example, a lot of rational people may come to different conclusions with the same facts. Is this a problem for efficient markets? Do we all need to come to the same conclusion? What are the key elements of human decision-making that make the markets efficient?

  • There is not much detail in the process. It is driven first by greed, insofar as successful investors draw imitators who try to do the same things. It is aided by information since it is the constant search for an edge that allows investors to find out more about their investments. It is greased by liquidity because it is by trading on this information that prices adjust to value. In effect, what keeps markets efficient is the belief that it is not and the actions that follow.

Here is information on Goldman’s Conviction Buy List (CL). According to Quora, the Goldman Conviction List (CL) showed an approximate 1.2% return over the last 5 years while the S & P was up 70.8%. It looks like Damodaran is right. Stay away from stock picking. It is dangerous to your wealth.

Given that stock picking is dangerous, one should invest in a simple S&P 500 index fund which mirrors the market overall and allows for time to let the portfolio grow. If you are younger, you might put 70% or more of your funds in an index fund. You should be ready for fluctuations but expect long-term growth. The balance goes to bonds and you add ownership of your own home for real estate.

What about regulation? According to New York Times, Oct. 23, 2008, when questioned about the crash, long-time Federal Reserve Chairman Alan Greenspan admitted that he put too much faith in the self-correcting power free markets.

As long as we have had markets, we have had booms and busts and to expect regulations to somehow prevent these is to put faith in regulatory authorities that I don’t have. The fundamental problem with the 2008 crash is that it originated in the most regulated sector of the market and it is possible that regulation itself (and the attempts by financial service firms to play games with the regulations) that led to the crash.

What about Boards of Directors? Can they help the average shareholder? “Many directors are themselves CEOs of other firms”, other than in the case of interlocking Directors, where on hand washes the other, what is wrong with that? Aren’t CEO’s of the companies among the most capable to serve on a Board? Who do you suggest as alternatives?

  • First, CEOs are on the wrong side of the corporate governance divide, pushing for less governance and more power. Second, being a CEO is a full time job and being a good director requires time and resources that CEO cannot bring to the board. I have no iron clad rules against CEOs and believe that we are missing the point by focusing as much as we do on board composition and as little as we do on board effectiveness (which I would measure by how often boards disagree with the CEO of the company).

Given that you believe in efficient markets and prices are generally right, under what conditions is it appropriate to do your own model of a stock and invest by your model?

  • You can always do your own model for a stock. It is whether you act on it that is determined by your belief about markets. (In other words, you only do this occasionally.) First, if you do your own model for a stock, know what you are doing, do your homework and assess value. Second, if that value is different from the price, start off with the presumption that your value is wrong and the market is right and check to see what you have missed. Third, if you decide that there is nothing fundamental that you have missed and you can afford to lose what you invest, take a position in the stock. Fourth, have faith in your valuation while also keeping the feedback loop open (where you adjust your valuation for new information that comes out about a company and new ways of thinking about its business model). Fifth, accept that if even if you do everything right, you can still lose money and be okay with that.
  • In other words, once in awhile, you can take a shot.


Please note the author on Quora states that this may not be completely fair as he does not have access to all of the CL list.