When Business Value is more than Business Value

When Business Value is more than Business Value

May 21st, 2011 // 2:09 pm @

The massive share price valuations for companies that are perceived to be in the right “Space” are back, we are into another bubble for prices of these stocks.

Eleven years it was almost anything on the Internet, and at the time I was deeply involved with Stepstone.com as it floated for hundreds of times it’s earnings. I remember sitting with a spreadsheet trying to make any possible growth in the real business we could perceive over even the following ten years, in any way link to the  share price. I failed because that was not how businesses are valued in a bubble.

This time around it is “Social media” and “China” that seem to be the magic words. And the values are in business terms completely unsupportable, as of today Linked in is trading at over 1,300 times its revenue!

So what drives what one would hope were sane investors to pay those kinds of prices? Well it is certainly not business performance. The logic that is expounded is essentially based around future profits, the nature of what these businesses do and the market areas in which they work have such powerful futures that these prices are justified.

In 2000 it was said that online job boards would in the future be so profitable that massively high stock valuations were justified. Well a decade on Monster.com the most successful of the online job boards is certainly profitable, but not particularly so, because like any other business if you work in a very profitable market you will attract competitors, and that stops any company making “Massive” profits for more than the very short term.

This cycle of hyped stocks goes back to the very beginning of stock trading, those who take the time to read the history might choose to remember the railway stock bubble in the UK of 1846, which burst just as certainly as our present bubble will.

History shows these bubbles so clearly. They happen regularly and go through a fairly predictable cycle, and crash. So why do people keep making the same mistake? Well, as a race we do not learn from history. We seem determined to make the same mistakes again and again, and we seem to need to experience something to learn from it.

And here in is the key, for all the sophistication of our modern world. And for all the very bright people who make these investment decisions; there is in us all a strong herd mentality, which makes us want to be part of the “Latest” thing. It is worth remembering for all modern business science and techniques, all business decisions are made by people, and as people we have flaws and perceptions that drive our decisions way more than logic.

What is interesting is working within a business with a massive and commercially unsupportable share value. The management of the company in it’s role as representative of the shareholders must push for the highest IPO value the market will stand, but then is committed to building the business to justify that valuation, even though they know that is unachievable.

One is then pressured to drive growth as fast as possible at almost any price, followed when the share price bubble inevitably bursts, to cut costs and make profit as quickly as possible.

These massive stock valuations and their inevitable collapse pulls management in different and equally unrealistic directions, damaging real business development.

As a result it is the unfortunate CEO who is often sacrificed, because shareholders are not ready to accept the reality, which is, it is really their unrealistic valuation that was the real problem.

This bubble will grow some more, then burst, and then we will do it all again.


Category : Blog &The Future

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