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Aswath Damodaran, a finance guru, discusses why “uncertainty regarding inflation destroys companies”

Aswath Damodaran advises investors in the United States to talk to people outside of the country to gain a better sense of how inflation may be frightening.

Aswath Damodaran

Aswath Damodaran, a renowned professor of finance at the Stern School of Business in New York, has advised that investors should talk to people outside of the country to understand why high prices can be frightening.

As he put it, “inflation drives everything we do in markets, and it’s distressing to see that people are so eager to reject inflation.”

Consumer prices in the United States increased by 8.6% in the year to May, the fastest rate of growth in 40 years, according to data released on June 10.

Expected inflation and unanticipated inflation are the two components of inflation that Damodaran considers.

“We can incorporate inflationary expectations into our financial assets… Expected inflation is, in my judgement, more moderate than current inflationary trends “As he sees it,

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The unexpected inflation, according to the professor, was the most terrible element. As a result, “you have a crazy scramble going on changing prices to reflect the increased inflation,” adds the economist, “when inflation comes in beyond expectations.”

Inflation is a death sentence for businesses

As Damodaran points out, businesses are capable of adjusting to inflationary expectations.

“When inflation increases above 2%, the rate of inflation has a greater tendency to fluctuate between 4% and 16% than when inflation is below 2%. This is a problem. Businesses are dying because they are afraid of inflation.” He says.

Infrastructure enterprises are wiped out by inflation. Firms that undertake long-term investments are doomed to failure if inflation turns out to be unpredictable, as it almost always is,” he says.

In the smallcap vs. the largecap debate

According to Damodaran, throughout the 1970s, the smallcap premium was the strongest. There is a reason why the more established you are as a firm, the more your business model has been set, the more adjustment is involved when inflation strikes you because you have to modify the way you conduct business.”

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A lesson learnt from the 1970s and 1980s, according to Damodaran, is that “financial assets” are better off when they are less harmed than when they are damaged more.

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