It’s been an interesting start in 2014. So far I’ve invested into a failing eCommerce business with a strategy contingent and mediated on the outright sale of a product. This past Monday I spent the day at Pakistan’s top management school — Suleman Dawood School of Business — as a judge for various competitions. The first half of my day as a judge for a brand strategy competition, and the latter half was spent judging and mentoring students on their business plan.
Gauging by the conversations I had with bachelors and masters students across disciplines, there appeared to be a divide between what was taught about brand strategy and business valuation.
Granted, this was due in part the fact that most of the venture capitalists they had encountered in the past included technologist drop-outs with a lot of money which they use to set themselves up as financial potentates — and whose evaluation methods include the task of lining people up to make meaningless 2 minute pitches. They would invariably spin their wheels looking for low-hanging-technological-fruit investments. Their valuations are at best not correlated with technical advancement and innovation.
A serious investor, however, looks at a company’s white papers and studies them. They look into a company’s personnel’s resumes. They take crash courses in the field that the company’s technology is in and in general spend time understanding what it is they are trying to do and beat the world out with.
The best indicator of a company’s value is its price-to-earnings ratio: At what price could you purchase the company? How does this compare to its annual earnings (revenues, less costs)? The price of a company should bear a reasonable relationship to its earnings. For some companies, a case can be made that its future earnings might be much higher than its present earnings, so that its price should rise.
It seems that many high-tech companies and investors have completely lost sight of these fundamental axioms of business valuation. The question is not, how many visitors view their websites, but what products or services do they provide? How much do they charge for them? What is the long-term demand for these services and costs? Who else can provide them? What costs are incurred to provide these products or services?
These questions bear upon future earnings. Present earnings are hard data. The price, or valuation, of a company must bear a reasonable relationship to its earnings. Lose sight of these basics, and you will likely lose your shirt.