This is how every company is valued. The point is not that the company is literally valued for some exact amount of money, but how it compares to other companies’ valuations.
There's a lot wrong with this, but I'll just say that there are many more than two ways to value a company, and if you used the first type he cites (taking the net present value of future profits) you are effectively ignoring any assets the company currently owns, including IP, cash, property, plant, and equipment, short-term investments, long-term investments, just to name a few.
> but their value is generally a multiple of current earnings, not "a pure function of future earnings".
Not sure what your objection is. The function is something like V = 3 * r, where V is the value of the company and r is the annual revenue. Boom, pure function.
I am torn about using valuation to rank companies. Valuation is is a vanity metric. Its just a number that VCs use to trade their capital, not the true worth of a company. You could raise $1 million from your rich uncle claiming to hold 0.1% of company and claim a $1B valuation. But then the question is, what do you use as the true worth of a company?
Valuations are generally a multiplier of yearly revenue, which makes sense. Valuations are, on paper, what you'd buy a company for, and in the old school look of things, how much the company made per year was a good metric, and you'd multiply it by several years, since you'd probably not buy it as a super short term investment.
Now, the actual multiplier values used for that... we can debate them for ages :-)
It’s a feedback to the CEO how good their company is. Buy putting a price on it (valuation), she/he gets feedback on how she/he is contributing to value increase.
in theory this factors in all aspects, e.g. more than just revenue, because it’s a comparison with other companies as well.
reality IMHO: it’s bullshit to manage short term valuation only.
That said, my original point was that we're looking at a financial ratio, and the first rule of applying financial ratios is that they are useless in a vacuum. We don't know the fundamental valuation of the company.
I didn't say it's inherently under- or over-valued, just that the ratio is meaningless.
That's a good point. I think you're referencing a Present Value calculation? My big issue with a lot of valuation techniques is they are based on exponential growth. That strikes me as overly optimistic, leading to decisions that overlook profitable businesses that do not grow exponentially.
No, pulling into the current valuation all the future profits is not the point of a valuation. If you did that, there would be no return to ever be had for the investors.
Under that premise, Facebook should have been valued at $200 billion at their IPO (or even earlier).
Google should have been worth $300 billion at their IPO in 2004.
Apple should be carrying a $20 trillion market cap using that calculation, pulling all of their future profits into their present valuation.
Investors do not normally reach a valuation for an investment today, based on profits ten years from now, with the expectation that the price paid today is equal to what the profits in ten years will justify. That's a recipe for not yielding any returns for ten years.
The point of a valuation is to invest capital into a company based on speculation of future returns to be yielded based on future profits, not to pay for all of those future profits with your investment today. The value is determined by the near-present estimation of what the business is worth, and with a potential bias elevating the valuation. The investor return comes from all of those future profits not being priced into the current valuation.
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