With Experience as Teacher, Investors Learn to Look for Value
There’s an old joke that goes like this: A little boy is walking with his grandfather, an economist. He spies a $10 bill lying in the street and runs to pick it up. His grandfather says sharply: “Leave it there! It must be fake. The market works, and if it were real someone else would already have picked it up!”
But there’s a more modern version. A young banker is evaluating a high-tech company seeking to go public. A senior (but not necessarily older) banker says quickly: “Grab it quick! The venture capitalists paid $40 million for it; it must be worth at least $100 million!”
Recently we’ve gotten back to a better approach to evaluating companies: actually examining the value of the asset in question. That’s why I personally like this stock market, although of course I can’t predict its near-term direction.
Over the last few months, a sense of reality has set in. Previously, investors were snapping up companies to sell them to other investors. Now they are looking at them with the eyes of someone who may be owning them for a while. That is, they are no longer looking for “a good story” to tell someone else, but rather a story they will believe for themselves.
They are once again interested in the business model, the value being created, the management’s maturity and ability to grow as the business evolves. All those old-fashioned business rules turn out to make sense. In the end, people buy stocks to own a piece of a company and the profit it makes.
Big audiences and heavy Web traffic are nice; brand names give a warm feeling; cover stories about the chief executive are validating. Page views and audiences and traffic and “buzz” were taken as indicators of future profits; it turns out they were merely indicators of investor interest in a market frenzy that is now over.
Companies have had trouble turning promising indicators into profits.
But it’s profits that pay for retirement, send kids to college and buy a better house. It’s profits that interest long-term investors.
For me as a venture capitalist, this cuts both ways. Start-ups are no longer asking for more money than they deserve, and their business plans are more realistic. As a small investor, I could rarely play in last year’s market: I couldn’t see putting up my own money for a company with no clear earnings prospects. (Well, I did make a mistake or two, but only a couple!)
Whether through foresight or simple whim, I have always preferred boring functions such as debt-collection or tracking products through a supply chain to “concepts” that depend on other people’s whims--such as taste in clothing, or simply reselling other suppliers’ products without any particular added value. I missed quite a few “opportunities” at a time when investors were scared of being left out and were bidding them up to fantastic values.
But now, opportunities are all over the place. “One venture capitalist turned me down and then told me to come back if I couldn’t get funding anywhere else. He was interested in ‘buying’ the company for nothing if he had the chance,” an unhappy entrepreneur told me.
That’s the downside. The companies I did invest in all need money for growth, and new money is hard to get these days. Investors are generally busy rescuing their own investments, not looking for new ones. It’s a challenge to raise money these days.
On the positive side, the new environment also imposes a healthy discipline. My companies are now focusing on their core business rather than going off into too many directions. They no longer want to crack the big time by going global; they want to make money in their home market.
And suddenly, we no longer have to compete with irrational exuberance, people who are funded to lose money for years. I’d much rather compete by running the business well than by raising money well.
It’s also easier to hire managers because some are simply not being solicited by five other companies; some come from companies that have folded or are capsizing . . . I mean, downsizing.
In some cases, the potential managers were not responsible for their companies’ failures; in other cases, they were. In both cases, they probably learned a lot from the experience.
It’s hard to learn from success because you don’t know where you were clever and where you were lucky; it’s usually easier to learn from failure, and to avoid the same mistakes the next time. This past year has provided many managers with years of experience.
To quote another old joke: A company fails and loses the investor $10 million. The investor calls the founder and asks him to join another company he has funded.
“I’m amazed,” says the founder. “After all that, you still want me to work for you!”
“I spent $10 million on your education,” says the venture capitalist. “Why should I let someone else get the benefit?”
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Esther Dyson edits the technology newsletter Release 1.0 and is the author of the bestseller “Release 2.0.” She is also chairwoman of the Internet Corporation for Assigned Names and Numbers. Send comments to edyson@edventure.com.
