Our friend and frequent/popular guest Andy Kessler wrote an excellent op-ed for the Wall Street Journal this weekend, giving his take on the sky high valuations we’re seeing bestowed upon Silicon Valley’s newest darlings – Team Social Media:
It’s no coincidence that last week, as the minutes from April’s Federal Reserve meeting suggested interest rates won’t go up for months or even years, Web professional network company LinkedIn went public at $45 a share. Its stock zoomed past $100 per share and settled at $94 on the first day. This valued the company at $9 billion, 30 times sales and 666 times earnings.
Yandex, also known as “Russia’s Google,” started trading on Monday and is now worth $10 billion. That’s a lot of rubles.
Overvalued? Undervalued? Stocks are worth whatever the market says they are worth. On Wall Street, perception becomes reality, though often fleeting. Of course, it’s not a real market. First, less than 15% of most IPO shares trade freely for the first six months (by longstanding practice, the rest are locked up). Worse, the Fed’s current near-zero interest rate policy distorts everything.
Let’s go back to fundamentals. Put simply, a stock is worth the sum of what investors think it will earn in the future discounted back to today. No one really knows a company’s earnings, its growth rate, or what discount rate or risk adjustment to apply. That’s what makes markets such a wild and crazy ride—stock prices change minute by minute. Industry news, new product uptake, interest rates, inflation, risks of recessions or wars or tsunamis all pose some form of risk and change collective perceptions.
The primary function of the stock market is to allocate capital to companies whose prospects it likes and starve those it thinks are past their prime. Yet these allocations and reallocations are based on guesses.
More from Andy at his website AndyKessler.com
The LinkedIn valuation sure looks rich to me – but then again, I’m a stodgy old school startup guy who believes in building a product that people will pay for. We’ve never raised outside funding, and hence, we don’t play in this “winner take all” world of web companies – where you either win the market, or blow up in spectacular fashion.
Recommended reading/listening: Our recent interview with Andy Kessler – talking tech, entrepreneurship, scale, and more!