There’s been plenty of feedback, mostly criticism in the public domain of the doomsday report by Citrini research which shook the markets last week. Much of the criticism is by the way of the critics providing their own scenarios as more likely. Given how fast the space is evolving and most couldn’t have been predicted thus far, it can be a bit overwhelming for any of us to get a reasonable grip of who is right about the future. The future is inherently unknowable yet we, humans crave for certainty. In this situation, we turn to an expert on uncertainties. Professor Aswath Damodaran, often referred to as the God of valuation, knows a thing or two about dealing with uncertainty given, by definition valuation is all about discounting cashflows from the future which are inherently uncertain. In this blog, he helps us with a framework to deal with AI’s uncertainties – both what it means for the world (or the economy) as well as our own jobs.
“The problem with all of these AI scenarios is that they are rooted in the weakest of responses to uncertainty, which is to either pick a scenario and to describe it in detail, without establishing, at least in qualitative terms, how likely that scenario is, in the first place, or to list out a whole host of scenarios, without making judgments on likelihood on any of them.
…For much of its history, financial analysis has been built around point estimates, where you identify key drivers, estimate the effects on your bottom line (earnings, cash flows) and make your best judgments. Thus, when valuing a company, you estimate the earnings growth on base year earning, how much you will reinvest of those earnings to grow to get to cash flows, and discount those cash flows back at a risk-adjusted rate to get to value. The problem with point estimates, where almost everything is uncertain is that you will be wrong 100% of the time, though you may still make money, if you are wrong in the right direction.”
This preference for point estimates and inability to deal with scenarios he blames it on our inherent difficulty with dealing with probabilities:
“Financial analysts and economists have been slow in adopting and using probabilistic approaches, where point estimates are replaced by distributions, and a single judgment on outcome by a distribution of outcomes. One reason, at least early on, was that economists and financial analysts often did not have rich enough data or powerful enough tools to use decision trees, simulations or scenario analysis in making their macroeconomic and investment judgments, but that is no longer true. Another reason may be that many in this group are uncomfortable with statistical distributions or probability estimates and stay away from using them, because of that discomfort. The third reason, at least for a subset of analysts, is a concern that being open about estimates and the errors in those estimates, which is visible to all in probabilistic approaches, will be viewed as a sign of weakness or lack of conviction on their part.”
Specifically, to the AI question, he demonstrates using the 3P method (possible, plausible, probable scenarios) and establishing key variables as:
- Disruption magnitude: whether AI will result in worker displacement or become tools for productivity enhancement, whether it will disrupt specific industries or most industries and how soon will it happen and
- Disruption aftershock: whether the impact is positive or negative, whether it is incremental or game changing, whether the short and long term effects are the same
We could modify the list of variables and then answer them based on our understanding of the subject and then create the 3P scenarios. You could read the professor’s take on AI using this framework in the blog but the key takeaway is the framework itself to deal with uncertain situations.
He ends the blog about how we should think about whether we in our individual professions will be relevant in the AI world. He applies it to himself where his colleague at NYU has actually developed a Damodaran bot and the professor whilst agreeing that the bot does much of what he does, he retains his edge with the following:
- “Generalist vs Specialists: I am a dabbler, an expert in nothing and interested in lots of different things, and I do think that gives me an advantage over a bot that is trained to focus on a topic and drill down. The specialist advantages stem from mastering the vast content in a discipline, but those advantages are diluted with AI entities that can also see that content, but the generalist advantage of using multi-disciplinary thinking with be more difficult for AI to replicate.
- Left and Right Brain: I value companies, and early in my valuation life, I decided that financial modeling was not the right path to value businesses, and that good valuations bridge stories and numbers. If the legend of the right and left brains holds, where the left brain controls logic and numbers and the right brain drives your imagination, a bot will have a tougher time replicating what you do, if you use both sides. That said, I have seen the Damodaran Bot get much better at story telling in the two years that I have watched it, and I need to up my game.
- Reasoning muscle: When faced with questions in the days before the internet, you often had no choice but to reason your way to answers. That may have been time consuming, and your answers might even have been wrong, but each time you did this, you strengthened your reasoning muscles. As we move into a period, where the answer to every question is online, on Google Search and ChatGPT, we are losing the need to exercise those reasoning muscles, and exposing ourselves to being outsourced by our bots.
- An idle mind: I am not a voracious reader nor a listener to podcasts, and since I don’t have much real work to occupy me, I also have plenty of vacant time, with nothing to do. I use that time to daydream and ponder about questions that capture my imagination, including why someone would pay billions of dollars for a sports franchise (like the Washington Commanders), how to deal with the risk of lava from a volcano hitting a spa and ruining its valuation and how streaming has broken the entertainment business. None of these posts include deep insights, but my guess is that the Damodaran bot would have trouble keeping up with my wandering mind.”
If you want to read our other published material, please visit https://marcellus.in/blog/
Note: The above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. The information provided is intended for educational purposes only. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India (SEBI) and is also an FME (Non-Retail) with the International Financial Services Centres Authority (IFSCA) as a provider of Portfolio Management Services. Additionally, Marcellus is also registered with US Securities and Exchange Commission (“US SEC”) as an Investment Advisor.
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