By its very nature, investment requires an assessment of the future. In order to invest any of your resources successfully, you must first understand the range of potential outcomes. Keirkegaard captured the dichotomy at the heart of investment. He said, “life can only be understood backwards: but it must be lived forwards”.
Since the 1980s, the equity capital market (ECM) has evolved at a pace which would perplex those who worked in it before Thatcher and Reagan. This is no truer than in the areas of forecasting and valuation. Through bull, bear and base, the equity market has sought to place a price on the shares underlying. It has done so using simple comparative ratio analyses – PERs and yields – through more exotic, balance sheet and cash flow derived models, to standalone models such as DCF and EVA.
And yet all require two key elements: the rationality of forecasts and the stability of the determining valuation factor. In order for valuations to be stable, the risk inherent in forecasts must be low and the metric or metrics used to value them understood.
In September 2021, how should the ECM forecast company prospects and value these prospects appropriately when, if we look backwards, there is much we are still trying to understand?
This is not a “ta dah” moment. We have no magic formula or equation which makes sense of the last 18 months in order that we can understand the next.
However, working with private companies over this period, it is a reflection that there is much the ECM can learn from the work being done in and around private companies all of which, if they are honest, aspire to a stock market listing. These companies do not manage their businesses to a value. They do not seek to optimize their balance sheets. They would love to manage their tax positions more closely and debate using equity or cash for dividends.
They run their businesses as hard as they can to bring their concept, their idea to a point where it makes money for them and for those who supported them.
We work with these businesses, and, at times, we are asked how the ECM would view them if they decided to IPO. We could comment on the emerging methodologies valuing cash flow. We could wax lyrical about the impact of low gearing on Enterprise Value ratios. We could discuss the choice of discount rate in a world where there are a few from which to choose.
The ECM, like any other market, is a slave to fashion. “Dans le vent” describes those companies with services and products which have a topical resonance with a favoured demographic. The largest companies in the world, by market capitalisation, do not extract minerals, bash metal, or manage your money. The largest companies in the world sell ideas. A phone that does everything. A website which shows your favourite movies. A vast warehouse which will deliver almost everything to your door for less money than anywhere else. A car which runs on electricity and was road-tested in space. The very text-based search engine which pointed you in the direction of the phone, movie, car, everything.
These businesses are tangible, produce revenue and earnings, and are very, very valuable. However, at their core, they are about ideas. They will become even more valuable when they produce more ideas not more revenue or earnings.
We may be at the banks of a Rubicon. Where we previously hesitated to cross, the influence of the Pandemic now spurs the building of bridges. Looking into the distance, we need pathfinders as much as we need ideas. Those who can see the qualitative appeal of an idea but whose experience of quantitative analysis can provide an anchor when the idea gets ahead of the execution.
VIVA Investment Partners is hosting the 12th annual Follow The Entrepreneur (FTE) Summit between 1st and 5thOctober 2021 on Mykonos. We will entertain ideas and debate their prospects in an environment which encourages looking, living forwards with the guidance that looking back can provide. We look forward to meeting you there.