Valuation matters.
What is valuation? It is determining what something is worth. There are various valuation techniques available, some more precise than others. Valuing a company, according to one leading finance professor, is “part science and part art,” as it requires making forecasts about the future.
Let’s review a couple of very successful companies where their valuation got ahead of their price.
Back in 2000, one major tech company’s shares got as high as $58 a share (split adjusted). It took over 16 years for the stock price to get back to this previous high, losing over 74% of its value at one point. What’s interesting: over this same time period, revenue more than tripled, net income more than doubled, and earnings per share tripled as well.
Do you think you could have held that stock for 16 years only to get back to break-even while the overall market did quite well?
Not many could.
It comes down to valuation.
Its price-to-earnings and price-to-sales ratios in early 2000 were extremely high by most historical valuation metrics. Over the course of the next 16 years these ratios were pushed down before finally coming back to more historically long-term averages.
Another company reached a high of $80 per share in early 2000 and 23 years later is still well below its high, despite revenue nearly tripling and earnings per share growing over 500% over that period.
This drives home two important points:
- Valuation matters.
- A company’s underlying fundamentals and its stock price can move in opposite directions for years.
-Paul R. Rossi, CFA