When you hear or read about billion-dollar companies being conceived in the news, have you ever wondered where do these companies get their valuation and how did they become such highly-valued companies?
Fundamental Foundations Of The Business & Investor Confidence
Is there a science to valuing these companies, or is everything just based on speculation?
The short answer to the question is that there is indeed a science to determining the value of a public-listed company. A company’s valuation is not being plucked out of thin air without any basis.
To become a billion-dollar company, the company must have strong business foundations, strong numbers and be able to win the confidence of investors.
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#1 Annual Revenue Growth
One of the key metrics investors look at when valuing a company is its annual revenue growth. One of the key reasons Apple is being valued so highly by the market is because of its high annual revenue growth.
Besides that, for a public-listed company to be valued at over a billion dollars, their annual revenue would also usually be more than a billion dollars.
Apple’s annual revenue for 2015 is more than USD 220 billion, Facebook’s more than USD 16 billion and Google’s more than USD 70 billion.
#2 Annual Profit
Besides revenue, a company’s annual profit also contributes to a company’s valuation.
For companies with huge annual profits well in excess of a billion dollars such as Apple, Google and Facebook, their stellar performance in this department is being reflected in the high price of their stock.
#3 Market Potential & Growth
However, it is important to note that not all billion-dollar companies are profitable.
The market also values the market and growth potential of a company. If the company is already generating a high revenue and has the potential to keep growing its consumer base and revenue by monetising it, the market might still value the company highly.
The logic behind this is that such companies are actually sacrificing profitability for growth. The assumption is that once the company captures sufficient market share, it can scale back on its costs to generate supernormal profits.
#4 Balance Sheet
Besides that, the health of a company’s balance sheet is also important.
A balance sheet is a statement of the assets, liabilities and total amount of capital that a company has at its disposal.
Billion-dollar companies would usually have a balance sheet with assets upwards of a billion dollars. In the case of more established companies like Microsoft and Apple, total assets held by the company can go up to more than USD150 billion.
#5 Company Direction & Future Prospects
While a company’s financials and growth numbers are important, intangibles such as the company’s general direction and future prospects have a significant effect on investor’s confidence in the stock and the company’s future too.
If the company is being led by a visionary founder or a capable management team that is constantly looking to reinvent itself and expand the company’s product offering for the future, it would reflect well in the company’s valuation.
Much of a company’s valuation is derived from the belief and confidence that the company will be able to continue shipping good products and generate good profit in the future.
#6 Industry Multiple
Lastly, valuations of public listed companies also depend on the common industry multiple for companies in the same industry as the company. Every industry has their own industry multiple where the market cap of a company usually fall within a multiple of its annual earnings. This ratio is also known as the price to earnings or P/E ratio.
There Is A Science To It
Knowing all these, you can be sure that there is a science behind how public-listed companies are being valued. Billion-dollar companies are able to command such a high valuation not by sheer luck, but by a combination of the above factors.
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