ELI5 how do company valuations work?

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zetsui
Posts: 67
Joined: Sun Aug 30, 2020 2:20 pm

ELI5 how do company valuations work?

Post by zetsui »

This seems to be a topic that comes up more and more wherever I look (ie startups, Japanese bubble being caused by overvaluations)

But how do valuations work and why are they important? Like the 90%+ not the whole breakdown of ebitda and 10ks (something I understand cursorily)?

For instance a 'travel startup' I saw on crunchbase had 1 acquisition for around $40 mill with 28 investors

https://www.crunchbase.com/organization/peek-com

And yet this company must be hurting during covid. As a private company their finances aren't available, no 10k or income statement breakdown. So how do I even know what I'm reading is independently correct, and isn't all fluff? I've seen dozens of private 'hot ex FAANG engineer' company go bankrupt all of a sudden, due to a lack of transparency like this.

So how can you tell the fluff from the cake?
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David Jay
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Re: ELI5 how do company valuations work?

Post by David Jay »

zetsui wrote: Sat Oct 17, 2020 8:10 amSo how can you tell the fluff from the cake?
With a closely held (i.e non-public) company you can't.

No, seriously. There is almost no way to figure out their financial details without being in a position (i.e. be a big enough potential investor) to sit down with them and go through their books. Which is exactly what venture capitalists do. It is a job, not something one dabbles with on the internet.

For you and I, they should all be assumed to be fluff. If you are inclined to purchase individual company stocks, stick with public companies who are subject to SEC reporting requirements.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius
Topic Author
zetsui
Posts: 67
Joined: Sun Aug 30, 2020 2:20 pm

Re: ELI5 how do company valuations work?

Post by zetsui »

David Jay wrote: Sat Oct 17, 2020 3:40 pm
zetsui wrote: Sat Oct 17, 2020 8:10 amSo how can you tell the fluff from the cake?
With a closely held (i.e non-public) company you can't.

No, seriously. There is almost no way to figure out their financial details without being in a position (i.e. be a big enough potential investor) to sit down with them and go through their books. Which is exactly what venture capitalists do. It is a job, not something one dabbles with on the internet.

For you and I, they should all be assumed to be fluff. If you are inclined to purchase individual company stocks, stick with public companies who are subject to SEC reporting requirements.
Thank you for that undersandging Jay...it seems intuitive to a seasoned investor like you but the boglehead philosphy makes more sense when you think about it. In essence its diluted down to a few good principles we got lucky with

So how would you view thegeneral stock market health? for me its a function of earnings , valuations, and cash flow growth?
alex_686
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Re: ELI5 how do company valuations work?

Post by alex_686 »

zetsui wrote: Sat Oct 17, 2020 8:10 am So how can you tell the fluff from the cake?
Wisdom, training, and skill.

Obviously I am taking the other side of David Jay.

There are multiple different ways. In general you model predictive cash flows and then discount them for tine and risk.

10 year t-bills are at 0.7%. Equity Risk Premiums are also at record lows. Thus future earnings have a high present value. If this is justified- well, time will tell.

I have not looked at your specific start up, but IPOs are harder. With established companies it is easier to estimate its progress. That being said I would think that Covid-19 would only have a modest impact. Think of a start up as a 1/2 finish factory. It is not producing much now but the real value will start kicking in a few years where, hopefully, Covid-19 should be in the rear view mirror.
Former brokerage operations & mutual fund accountant. I hate risk, which is why I study and embrace it.
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