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No Mas, No Mas - The Vale Chronicles Continued - Value Investing Professor Damodaran

I have used Vale ( NYSE:VALE ) as an illustrative example in my applied corporate finance book; as a global mining company, with Brazilian roots, it allows me to talk about how financial decisions (where to invest, how much to borrow and dividend payout) are affected by the ups and downs of the commodity business and the government's presence as the governance table. In November 2014, I used it as one of two companies ( Lukoil [LUKOY] was the other one) that were trapped in a risk trifecta, with commodity, currency and country risk all spiraling out of control. In that post, I made a judgment that Vale looked significantly undervalued and followed through on that judgment by buying its shares at $8.53 per share. I revisited the company in April, with the stock down to $6.15, revalued it and concluded that, while the value had dropped, it looked undervalued at its prevailing price. The months since that post have not been good ones for the investment, either, and with the stock down to about $5.05, I think it is time to reassess the company again.

Vale: A valuation retrospective

In November 2014, in a post titled "Go where it is darkest," I repeated a theme that has become a mantra in my valuation classes. While it is easiest to value mature, moneymaking companies in stable markets, I argue that the payoff to doing valuation is greatest when uncertainty is most intense, whether that uncertainty comes from the company being a young startup without a business model or from macroeconomic forces. The argument is based on the simple premise that your payoff is determined not by how precisely you value a company but how precisely you value it relative to other people valuing the same company. When faced with boatloads of uncertainty, investors shrink from even trying to do valuation; even an imprecise valuation is better than none at all.

It is to illustrate this point that I chose Vale and Lukoil as my candidates of doom, assaulted by dropping commodity prices (oil for Lukoil and iron ore prices for Vale), surging country risk (Russia for Lukoil and Brazil for Vale) and plummeting currencies (rubles for Lukoil and reais for Vale). I valued both companies, but it is the valuation of Vale that is the focus of this post and it yielded a value of $19.40 per share for a stock that was trading at $8.53 on that day. The narrative that drove my valuation was a simple one - i.e. that iron ore prices and country risk would stabilize at November 2014 levels, that the earnings over the last 12 months (leading into November 2014), which were down 40% from the previous year's numbers, incorporated the drop in iron ore prices that had happened and that eventually Vale would be able to continue generating the mild excess returns it had as a mature mining company.



I did buy Vale shares after this analysis, arguing that there was a buffer built into earnings for further commodity price decline.

In April I revisited my valuations as the stock prices of both companies dropped from the November 2014 levels, and I labeled the post "In search of Investment Serenity." The post reflected the turmoil that I felt watching the market deliver a negative judgment on my initial thesis, and I wanted to check to see if the substantial changes on the ground (in commodity prices, country risk and currency levels) had not unalterably changed my thesis. Updating my Vale valuation, the big shifts were twofold. First, the trailing 12-month earnings that formed the basis for my expected value dropped one-third from their already depressed levels six months earlier. Second, the implosion in Petroleo Brasileiro ( NYSE:PBR ), the other large Brazilian commodity company, caused by a toxic combination of poor investments, large debtload and unsustainable dividends, raised my concern that Vale, a company that shares some of the same characteristics, might be Petrobrased. Again, I made the assumption that the trailing 12-month numbers reflected updated iron ore prices and revalued the company, this time removing the excess returns that I assumed, in perpetuity in my earlier valuation, to arrive at a value per share of $10.71.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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