I know a thing or two about bubbles, both owning and leasing properties in Sydney. But while we’ve seen valuations across various asset types rise and fall, the economics of supply and demand eventually even the score. God bless capitalism!
But some of the business valuations floating around right now are paper-thin if we look at the basics of business – in particular, I’m talking about the ‘new wave’ of business models in technology, finance, social and the like. I believe businesses are worth what someone is willing to pay for them – and this has nothing to do with its actual value. We know this because most of us are marketers – the creation of subjective value is at the heart of what we do! We’re loved and hated for it.
Now, I can hear all the venture capitalists (and VC wannabes) ranting that I don’t fully understand the internal rate of return, yield, earnings, multiples and a whole raft of other jargon. But many over-hyped companies with their ‘revolutionary’ models are actually losing money despite their ‘future earnings potential’!
The more I think about these business valuations, the more I’ve started to question some of them. But even as I write, I have a little voice in my head asking me whether I’ve got this right; is this just a paranoid voice or a canary in the mine?
In the early 2000s, the first canaries in Enron’s mine shared this sentiment when they spoke out against its then famed, and now famously ridiculed, ‘mark-to-market’ accounting. ‘Mark-to-market’ essentially meant Enron reported anticipated profits as if they’d happened already (sounds a lot like ‘future earnings potential’). That’s pretty ‘creative’ accounting! The company crashed in 2001 when the reporting proved not to be worth the paper it was shredded on. It begs the question, will history repeat itself?
Now take Apple, for example – if Apple is the world’s most valuable company (market cap of over USD $700B) does this mean it has $700B in tangible assets? No. A large portion of this valuation comes from difficult to quantify assets like goodwill, network, employees, branding and investor sentiment. So, when unsophisticated investors like you and I (yes, I said that, don’t be offended, that’s how retail investors are technically classified) buy shares on the major stock exchanges what are they actually buying?
Let’s look at another famed model, Facebook. Despite its enormous reach, it has a mind-blowingly low profitability. When you divide the profit by the user numbers – it’s less than $2 per user. Wall Street Journal’s technology expert, Christopher Mims, said it best when he ruthlessly explained Facebook’s business model: ‘Facebook is a large, inefficient engine for transforming electricity and programmers into a down-market place to sell low-value advertising’. It appears even tech heads have a sense of humour!
So here’s the state of play: the market takes new business models with valuations and confusing variables that nobody can possibly predict, oversimplifies and over-hypes the numbers before using them to drum up the media, all in an attempt to woo unsophisticated investors out of their retirement savings! Where are the ethics in that?
However, history shows supply and demand eventually pop these valuation bubbles – we’ve seen this recently with the weakening Australian Dollar, the fall of China’s stock market, the GFC and many grossly over-valued companies in the stock market losing stock value.
And when these bubbles pop – and they all do – all you’re left with is a paper-thin valuation and a whole lot of trouble surrounding what your money actually bought you… Because even ‘unsophisticated’ audiences wise up sooner or later.
Jeff Cooper
Founder
Step Change Marketing