Valuing IPOs and Stocks
An initial public offering (or IPO) is the act of a company or its existing shareholders selling some of the company’s shares and then allowing the general public to buy, sell and hold their shares freely.
Share price comparisons from one company to another are often made by stock hobbyists. They might say, “Beyond Meat is worth $130 per share. Impossible Foods has a better product and outlook so if they IPO, won’t one of their shares be worth more?”
Not necessarily.
Shares are like equally-sized slices of a pizza. The size of the slice depends on the overall size of the pizza and the number of slices it’s divided into. Similarly, the overall value of a company varies as does the number of shares outstanding.
While every Zamboni’s large has 12 pieces, every large company has a different number of shares.
Valuing a company can be likened to valuing real estate. Just as an established apartment building earns rent, an established business earns profits. Both values are determined by the amount an owner expects to earn.
And just as a plot of land has value for the rent-earning building that can be constructed on it, an unprofitable growth company has value for the profits it might earn in the future.
Whether it’s real estate or a publicly-traded company, successful investors typically care about how much they will make this year and further into the future. The more certain and sooner the earnings, the more an investor will pay for them.
All of this applies to how traditional professional investors value public companies. But sometimes, the professionals are not in control.
2021 has seen a huge increase in non-professional day traders who have different ideas about valuation than what is described above. And so far, it’s worked, as more and more retail investors climb aboard.
Does their success disprove the traditional valuation approach? Maybe in the short-term, but not in the long run. Real estate speculators might have paid a high price compared to the rent for a home in 2005, but they looked like geniuses when they flipped it.
Early success often convinces others to join in, or double down. As long as you can find a greater fool, your investment can be a success.
