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IPO Stocks - How to Value Any Company and When to Buy | Stock Market for Beginners - YouTube
Channel: Let's Talk Money! with Joseph Hogue, CFA
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The hot new stock IPO is out but is it going
to be like Facebook which has jumped five-fold
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since its IPO or a total bust like so many
others?
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In this video, I鈥檓 sharing the exact process
I used to value IPO stocks for venture capital
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investors including the two valuation methods
that tell you how much a stock is worth.
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We鈥檙e talking investing in IPOs today on
Let鈥檚 Talk Money!
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Beat debt.
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Make money.
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Creating the financial future you deserve.
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Let's Talk Money!
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Joseph Hogue with the Let鈥檚 Talk Money channel
here on YouTube.
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I want to send a special shout out to everyone
in the community, thank you for taking a little
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of your time to be here today.
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If you鈥檙e not part of the community yet,
just click that little red subscribe button.
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It鈥檚 free and you鈥檒l never miss an episode.
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This is a video I鈥檝e been wanting to do
for a long time.
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I worked as a venture capital analyst for
years, valuing private companies and pre-IPO
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stocks.
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I created and managed a team of analysts for
a Canadian VC firm.
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If you want to know how to make money investing,
it鈥檚 this kind of early-stage investment
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that produces double- and triple-digit returns.
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I planned on doing the video around one of
the big IPOs this year but I didn鈥檛 want
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it to be specific to any one company.
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Those videos like, Should you invest in the
Uber IPO or this or that IPO, are hugely popular
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but you鈥檙e pretty much stuck after that.
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Instead, I want to give you the tools you
can use to value any stock IPO.
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I鈥檓 going to show you the exact process
I went through to value a private company
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before its initial public offering.
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I鈥檒l reveal the valuation methods I used
that told me exactly how much a stock would
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be worth and whether to buy at the IPO price
or to wait.
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And trust me, you do not want to be wrong
here.
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IPOs can provide spectacular returns but many
lose money from the start.
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Research by Renaissance Capital shows that
almost half the new IPOs trade lower by the
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end of the year and one-in-four lose money
on the first day.
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To show you how to value IPOs, I鈥檓 going
to be using the same process I used in a 2015
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report to private investors for a funding
round in Pinterest.
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I was hired to provide a valuation for investors
in what turned out to be the social media
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giant鈥檚 last big funding round before it
went public at a $14 billion valuation.
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First, I want to talk a little bit about the
IPO process, how a company sells shares.
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I also want to point out a few of the reasons
why I generally wait after the IPO to buy
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a new stock and how you can use the analysis
I鈥檒l outline to find the right price to
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buy.
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By the time a company files to issue stock
in the public market, it might have been around
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for a decade as a private company.
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In fact, most companies are acquired rather
than have an IPO.
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In my work as a venture cap analyst, I鈥檇
say maybe one out of ten companies would eventually
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IPO shares.
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For example Facebook raised money for the
first time in 2006 but would go through 14
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funding rounds from private investors before
its IPO in 2012.
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It raised just over $2.3 billion in private
funding and was valued at $104 billion when
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it issued public shares.
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So that IPO made early investors filthy rich.
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One of the first private investors, Peter
Thiel turned a $500,000 investment into a
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billion dollar payday.
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But this is one of the reasons why you really
need to know how to value a company at its
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IPO.
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By the time a company gets to this point,
the private investors have sucked just about
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all the value they can get out of the investment.
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That鈥檚 what they do, looking for companies
that can grow cash flow to be sold off or
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issue shares, and as an analyst that鈥檚 what
I helped them do.
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Another reason I鈥檓 generally skeptical of
buying in on a new IPO is what鈥檚 called
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a lock-up period.
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Understand that before a company issues stock,
besides all these private venture capital
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investors, it鈥檚 also sold shares to employees
and large institutional investors.
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To keep these from dumping their shares at
the IPO for that quick jackpot, companies
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have a lock-up period of between three to
six months that insiders and early investors
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can鈥檛 sell their shares.
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The problem is that when the lock-up period
expires, you get a lot of people looking to
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sell their shares.
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Obviously not everyone is going to dump all
their shares but it can still be a big wave
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of shares on the market for months and just
simple supply and demand factors here.
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When you have a lot of supply, so lots of
shares trying to be sold, but demand stays
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the same, then prices have to come down.
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We see a good example of the lock-up period
problem with Alibaba.
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Its lock-up period ended March 2015 and at
this point just the employees and insiders
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owned 437 million shares or about 18% of the
company.
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So you see here for about four months, the
share price had a really tough time breaking
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higher because you had a big wave of sellers
trying to unload some or all of their shares.
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So two reasons you need to be extremely skeptical
of buying new stock in an IPO, two reasons
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you absolutely need to do the analysis and
know the fair price for those shares.
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Now we鈥檙e going to get to that valuation
method I used for venture capital clients
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but I want to get your opinion on something
first.
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I want to start doing videos on different
types of investments on the channel but want
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to know in which are you most interested for
example; stocks, bonds, real estate, gold
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and other metals investing or maybe investing
in currencies.
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So let me know in the comments below, what
types of investments would you like to see
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covered.
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Let鈥檚 walk through that valuation process
you can use for any new stock or IPO.
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This is the process I used to value Pinterest
in 2015 on its Series G funding, just four
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years before it issued shares.
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There are four parts to the process I used
to value early-stage and IPO companies.
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You first have your qualitative analysis so
you鈥檙e looking at the industry and competitive
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landscape.
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You鈥檙e looking at profits and positioning
of similar companies already in the industry.
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Then you鈥檙e going to look at the strategic
focus of your IPO target and management鈥檚
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ability to deliver on any advantages.
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I鈥檒l be making another video detailing this
part of the process, how to really understand
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an industry and do this deep analysis.
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For the rest of this video, we鈥檒l focus
on the valuation side using two methods that
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I鈥檒l share.
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Next you鈥檙e going to dig into the company鈥檚
financial statements and build a cash flow
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model.
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This is where I would take management鈥檚
forecasts for growth, which are ALWAYS overly-optimistic
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by the way, and build out a realistic expectation
for cash flows and income.
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I鈥檒l be doing this in another video as well
because I want to get to these next two steps.
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These next two, the mergers and acquisitions
valuation and the comparables valuation, are
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where you really start to see how much this
new stock is worth.
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I鈥檓 going to show you exactly how to put
these together using public information to
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estimate a fair value for an IPO stock.
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Let鈥檚 get to those two valuation measures
that will show you how much a company and
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its stock is worth but first I need a favor.
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If you like the video and think it will help
you value an IPO, tap that thumbs up button
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below or let me know in the comments.
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So there鈥檚 two methods we鈥檒l look at,
the M&A or mergers and acquisitions method.
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This one looks at how much companies are paying
to acquire a similar company to the one you鈥檙e
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valuing.
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In our Pinterest case, we鈥檒l be looking
at acquisitions in the social media space
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to estimate how much the company is worth
based on sales and monthly users.
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The other method is done on competitor multiples,
so looking at other publicly-traded companies
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to see how much they鈥檙e trading for on a
sales or active users basis.
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Let鈥檚 look at the table here showing us
that M&A method for Pinterest and I鈥檒l show
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you how to put this together but I want to
point out a few things first.
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This first column is the date the acquisition
was completed so the date the buying company,
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the acquiror, was saying that this target
company was worth this much.
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Next we have the industry in which the target
company operates.
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This is important because like we鈥檝e talked
about before on the channel, you have to compare
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stocks with similar companies in the same
industry.
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For our Pinterest example, we鈥檒l look for
other acquisitions of social media companies.
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The next two columns are self-explanatory,
the target company and the acquiror, followed
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by the transaction value.
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This is the total price paid to buy the target
company and you want to make sure this includes
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the value of cash, stock and any debt.
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Finding acquisitions to compare in your IPO
analysis is pretty easy.
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You can do a search in Google for the name
of the industry and acquisitions and then
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just look through the results for lists of
past deals.
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These last two columns are the most important
and this is where you鈥檙e going to get that
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company valuation.
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You want to get an idea of how much acquirors
are paying for the sales and other financials
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of those target companies.
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Sales or revenue is a common measure and sometimes
you鈥檒l see earnings before interest, taxes,
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depreciation and amortization or EBITDA in
this second column.
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Here鈥檚 where you need to know about the
industry though and where some of that market
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analysis comes in handy.
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Here since I know that monthly active users
is one of the most important measures for
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a social media platform, I鈥檓 going to find
the value on these deals according to how
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many users the platforms had at the time of
the acquisition.
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Finding these deals is easy with just a Google
search for the industry then acquisitions.
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The part where you鈥檒l have to do a little
research is to find the revenue and your other
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measure at the time of the acquisition.
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For example, when I did a search for Social
Media acquisitions, I found a couple of articles
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that listed out all six of these deals but
none of them showed revenue and only a few
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showed the monthly active users statistic
I needed.
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To fill out the table, I had to search Google
for things like the target company鈥檚 name
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and revenue or the target company鈥檚 name
and acquisition valuation.
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So this will take a little more time but you
can usually find the estimates for your table.
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Once we鈥檝e got the sales and active users
for each target company, then you can take
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the transaction value so that deal value and
divide it by the number.
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For example Yahoo bought Tumblr for $1.1 billion
in 2013.
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Tumblr booked about $13 million that year
and had approximately 300 million users.
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So we took that $1.1 billion divided by 13
million in revenue to get the 84.6 number
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you see and the $1.1 billion divided by 300
million monthly active users for that 3.7-times
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multiple.
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We find that transaction value multiple for
each deal then you see I鈥檝e created some
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summary stats here below.
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I like to list these out below, the average,
median, the highest multiple and the lowest.
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Being able to see it here gives you an idea
of how close the deals are, you can see which
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were the highest and the lowest.
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Then you have to question why, why was Microsoft
willing to pay so much more per sales and
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per users for Yammer in 2012 than it did for
LinkedIn in 2016?
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And while you鈥檙e asking these questions,
you start thinking about how closely your
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new stock IPO compares to these deals.
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Is it pretty much like the average or does
it have a competitive advantage that might
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mean its valuation should be at the high end?
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Generally, I鈥檒l use the median multiple
here and apply that to the company we鈥檙e
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analyzing.
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Because there鈥檚 quite a bit of variation
here, I decided to go with the multiples in
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the LinkedIn deal.
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Both LinkedIn and Pinterest are relatively
well-developed platforms compared to some
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of these other targets.
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The LinkedIn deal was the latest so it鈥檚
probably a little more applicable to today鈥檚
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values.
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So if we take the multiples on the LinkedIn
deal, this 9.5-times sales and 60.5-times
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monthly users, and we multiply those with
the estimates we have for Pinterest for about
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$1.06 billion in 2019 revenue and 291 million
monthly users, we get this estimate of value
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from about $11 billion to $17.6 billion.
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Now that鈥檚 still a pretty big range but
I鈥檒l show you how to narrow it down after
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we walk through our second valuation method
but this gives us a start on valuing our new
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stock.
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The second way we can value an IPO or a new
stock is by comparing it to similar companies
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already trading on the market.
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This is called the public comparables or market
approach.
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Here you see the table and this one is going
to be slightly easier than the M&A approach.
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You first do a Google search for publicly-traded
companies plus the industry so here it was
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pretty easy to get a list of five social media
companies with shares available.
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Next you can go to any investing platform
or Yahoo Finance and find the rest of your
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information.
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You鈥檒l find the market cap of the company
which is the share price times all the shares
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outstanding, so the total market value.
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You can look on the company鈥檚 financial
statements to find its revenue or sales for
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the last year.
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Here I had to do a search to find the current
data for monthly active users on each platform.
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Again, usually you鈥檒l use sales and EBITDA
for these two columns but I knew from my research
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that monthly active users was a better measure
so I decided to use it for valuation.
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You do the same thing here as in the M&A model.
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You take your market cap of the company and
divide by the metrics you found.
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For example, Facebook books roughly 56 billion
in annual sales and has 2.38 billion monthly
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users.
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Taking this $524 billion market cap divided
by each of those numbers gives me the 9.4
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multiple and the 220-multiple you see here.
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Again you can show the summary stats below
and it鈥檚 kind of all over the place.
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Investors are paying about nine-times sales
for established platforms like Facebook and
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Twitter while Snap gets a little higher valuation
and Yelp is in the doghouse.
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The multiples on monthly active users are
really revealing here.
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For platforms like Facebook and Twitter which
have their monetization down, they know how
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they鈥檙e making money off users, investors
are paying much more per active user.
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On the other hand, for platforms like Snap
and Yelp which haven鈥檛 really figured out
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quite as well how to make money, investors
aren鈥檛 paying nearly as much per user.
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Here I decided to use the price multiples
for Snap because I feel like it and Pinterest
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are very close in their life cycle.
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Both have a high number of monthly users but
have struggled a little to find ways to monetize
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that base.
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Growth is stronger on Pinterest though sales
are a little higher on Snap.
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So when we use that 12.1-times sales multiple
and the 53.1-times MAU on the data we have
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from Pinterest, we get these two estimates
for $12.8 billion and $15.45 billion.
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Now I know what you鈥檙e saying, we鈥檝e got
two different valuation methods, each with
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two estimates on the value of Pinterest.
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Which is it?
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How do I know what is a good price for this
stock?
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This is where you use a little of that market
analysis on the company and put together what鈥檚
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called a blended valuation.
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So if you look at the two methods, you get
a low estimate around $10.1 billion and a
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high around $17.6 billion.
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Taking the average of the two, you get a low
around $11.5 billion and a high around $16.5
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billion and an average centered right around
$14 billion which is where Pinterest is trading
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now at just under $26 a share.
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So we have an idea that fair value is right
around where the stock is trading.
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Now we look at growth and that competitive
positioning from our market analysis.
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Growth in revenue and monthly users is stronger
than a lot of the other social platforms.
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I like the fact that Pinterest has elements
of search in it鈥檚 function rather than just
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a social platform.
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I think it makes it much more monetizable
and less susceptible to competition compared
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to pure social platforms like Twitter and
Snapchat.
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I think the revenue growth is there, like
that comparison to Facebook, Pinterest just
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needs to prove its monetization plan.
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Take all these together and you can make an
argument that the shares should be worth the
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top end of those estimates rather than towards
the bottom and a good deal from here.
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Now if you were doing this on a new stock
waiting to IPO, it would be no different.
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You would have the proposed IPO share price
and a market cap for the company to use in
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your analysis.
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Go beyond one single stock to see how I put
together our stock market challenge portfolio
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by clicking on the video here.
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Our dividend portfolio is beating the market
with nearly a 20% return so far and more than
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6% higher than the stock market.
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