(reposted from my entry at allconsuming.net)
I’ve got an issue with one of the fundamental premises in this book. The book asserts that the future potential business value of a company can be measured by determining a ratio between market cap (number_of_shares * share_price) and revenue (at least I think it was revenue!). And I believe this is a generally sensible and applicable approach. The rationale that is used is that investors understand a companies business model, and can see future benefit in the company, so they are willing to pay more today, for expected future returns in the company (the whole NPV of investment thing).
Now, this premise presupposes that investor actually understands and analyses the businesses model â€“ and that is not always the case. Many investors do not perform the due diligence involved to look at business models, and often invest in industry they don’t understand, because of a â€œbandwagonâ€ type effect. I can see that this effect could also be accentuated by people using momentum investing, or pure technical analysis. They would drive up prices of stocks, when a business may not have a sustainable model.
This book was written in 1997 (I think), and I wonder if the author would refine his theory if this book was written now given the .com boom and bust. Lots of business, with a high market cap, and no future earnings. Suddenly people thought â€œWTF are we investing for? There’s no sustainable model here?!â€ and the market fell over.
I’d be interested in others thoughts on thisâ€¦.