I write mystery books, usually murder mysteries. My stories are not based on deep analysis of much of anything, other than human nature and a little common sense. By design the characters are flawed, but interesting (I hope). Perfect characters would most likely not be involved in murder and no doubt would not be very interesting; or at least would be hard (for me) to relate to.
In my other life, I’m involved in business. Some of that activity is focused on financial analysis and forecasting. I look at businesses’ data and try to determine the value of that on-going business. This is taking historical numbers and placing a current value for the future prospects of the enterprise.
Earnings (or profits, or cash flow, or some other measure) are a key to calculating value. In my case I’m valuing non-public, mid-size businesses and the measure is usually something called EBITDA, earnings before interest, taxes, depreciation and amortization. Whatever the particular measure, it is based on the assumption of profits—in the future. Value is always a guess about the future.
This week’s blog might seem entirely off my normal subjects of books and writing; but I will connect the dots at the end of this article.
The over-hyped and inflated value of the stock market has created an unreal (or unsustainable) expansion of market value. Because I have a good sense of how non-public companies are valued, the public companies appear to be super over-valued. The why of this is due to the vested interest by almost everyone in an over-valued market. Politicians want a hot stock market so they can claim it is because of their wise policies, all of Wall Street wants a thriving market because they make money, investors want a growing market because, duh! No one wants a down market (there are some marginal players who bet on a down market but are a relatively small group), so all of the hype is promoted by almost everyone. No one suffers from an over-valued market, or so it seems.
Except, it is not based on any viable measure. The most common measure on public stocks is price earnings (PE). This is a common sense measure of the return in profits as a percentage of the price of the stock. So what would be a good return on the stock; 10%, 20% or what? The PE does not give you the percentage, but the number of times the stock is of earnings. So earnings of $1 with a PE of 10 would be a stock price of $10. A PE of 10 is a 10% return. A PE of 20 is a 5% return. A PE of 50 is a 2.5% return. This is a list of some of the top companies selling at a PE of 50 or more (that is a 2.5% return or less):
- Amazon.com (AMZN)
- Liberty Global (LBTYA)
- Salesforce.com (CRM)
- Tesla Motors (TSLA)
- Netflix (NFLX)
- Vertex Pharmaceuticals (VRTX)
- Twitter (TWTR)
- Illuminata (ILMN)
- General Growth Properties (GGP)
- Prologis (PLD)
It is very unlikely a private company would sell at anything close to those PE ratios. Because a large portion of that value is based on speculation. Speculation is the anticipation that you as an investor can sell the stock you purchased at $1 for $10 in the future. So that speculation is based on your perception of the rise in value of the stock, which is not necessarily tied to any kind of earnings. You hope someday in the future an investor (sucker?) will pay 10 times what you paid knowing (mostly likely) that the company’s earnings or assets or any measure of value will mostly likely not grow all that much. Your investment is a leap of faith based on market hype. But, you might say, lots of people make a ton of money doing just that! And, yes, they do; until they don’t.
In my private company mid-sized world, a common measure of value is a multiple of EBITDA. In most industries the value of a business will be in a range of 4 to 6 times adjusted EBITDA. There are exceptions of course, but on average that range will cover it. The EBITDA multiple for public companies is readily available; so these are a few of the above companies EBITDA multiple:
- Amazon 27
- Netflix 64
- Prologis 31
- Twitter 22
In most cases public companies will always be worth more than private companies (no reason to get into that briar patch—no doubt you’re already wondering when this will end—soon.) But if a private company’s higher end value is based on 6 times EBITDA; how can a company like Netflix be worth 64 times? The simple answer is that under any normal economic measure, it isn’t. What creates that higher value is speculation—the hope a future investor will pay you more for the stock you purchased—regardless of the underlining economic factors.
At some point this overvalued reality will become evident and the whole mess will collapse. The bubble will pop. In case you’re wondering, I have no idea when that might happen; I just know it will.
This is an oddball way of letting you know that I’m in the process of writing some business books. Some of you may be aware of my background (CPA, CFO and other initials without much meaning), and understand that a murder mystery writer penning business “how to” guides is not completely farfetched.
At one time when I was considering this, I thought about using a pseudo-name for the business stuff; so not to confuse readers of Ted Clifton’s mystery books. After a little thought, decided that was just stupid. So I write mystery and non-fiction business books, it may be odd to some but not to me; so I will use my real name and assume the readers can tell the difference.
The first book in the business series, which will be under the series name Success Paths, will not be out until the latter part of 2020. These books will have little value to you unless you own a business or are starting a business. Of course, there may be people who just buy business books for their entertainment value, but that’s got to be a fairly small group. For those people, I would highly recommend my mystery books, easier reading and definitely more entertaining. As the Success Paths business series progresses I will keep you advised.