Why Valuation Is Subjective and How to Think About It

Posted by Jacob Radke

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You’d never, as a reasonable person, pay more than $0 for a piece of dog crap. When we talk about investing a very common gauge of valuation is peer to peer analysis. So while there are companies out there that will pay, actually, thousands of dollars for your crap, literally, there are not companies that will pay that for your dog’s crap.

But if we were to compare those two things and there values the same way we would compare two companies, we’d say either human crap trades for way too much or that dog crap is cheap.

But which one would you rather buy?

The human crap actually has some value to researchers discovering lifesaving cures, whereas you’d be hard pressed to find someone using dog crap in a similar manner.

By that standard, even though human crap trades at an “extreme multiple” to the crap market, it would be the obvious choice.

That’s an extreme example of valuation and cheapness.

What is something ever truly worth?

Why at any point should Nvidia’s price to earnings (price per share divided earnings per share - a very common valuation metric) be different than Intel’s?

Is the semiconductor market similar to the crap market wherein only a few players actually have value and the others are dog crap? Certainly not, they all have use cases, you don’t become a billion dollar enterprise by accident.

Intel still owns a substantial portion of the semiconductor market, why shouldn’t that have a premium over Nvidia or AMD? Maybe because Intel is losing that market share?

And here’s a question for you. How much should Apple’s M2 GPU (released June of 2022), which has been used in millions of Mac products, be worth? If every Mac takes at least one M2 at lets say 10 million Mac units sold between June and December of 2022 that would be 10 million M2 GPUs.

If Apple was to say release the M2 to the market at a price point similar to that of Nvidia’s A100 at $10,000 a piece, just it’s demand alone would account for nearly $100 billion in sales. The iPhone sells about $150 billion per year. Nvidia currently trades around 30 times sales, which would make Apple’s M2 worth about $3 trillion, Nvidia’s projected $43 billion in sales is valued around $1 trillion.

This is all very speculative, but I think you see the point. Why should things be valued differently? Sure Apple’s only uses the M2 in house, but at the same time if they turned that into a new revenue stream for the company what would happen? Would/should Apple suddenly start trading at a Nvidia multiple? And if so why shouldn’t Amazon, Google, and Microsoft be the same? They have their own GPUs.

And it is very hard to say that Apple, Microsoft, Google, Amazon, or Nvidia are dog crap companies, yet on a peer to peer valuation analysis the former four are much cheaper than Nvidia.

So does that mean Nvidia should be the choice, or the others? Ultimately I can’t answer that.

Let’s take it one step deeper. If you compare all five to the S&P 500, you’d say the market is cheap and those five are expensive.

If you take large and mega sized companies to small and mid sized companies, why should small companies be at a discount to large companies, and why has it changed from there being a small premium to there being a large premium in the last decade?

What is something ever truly worth? It is so subjective, and that is what you have to be careful in.

Those who have no strategy are doomed to fail, by lack of conviction. You may get lucky in the short term, but suffer in the long term.

Valuation is an incredibly hard thing to wrap your mind around. But here’s a framework in how you can think about this.

  • Generally companies that have and are projected to grow revenue and earnings faster than peers have a premium to peers, because they are growing faster. It’s the same reason why lower yielding bonds are priced down when yields go up.
  • Generally the more indestructible, a very subjective term, a business’s earnings and revenues are the higher of a premium they will have. When it hard to kill the beast, the beast lives on longer and longevity in markets matters.

Those two things are very important because behaviorally investors will fly to safety and quality (indestructibility) when things get dicey. And when investors are feeling risky they will put a lot of chips in the former. Speculation gets killed over the long term.

Always ask why something has a premium and if it is worth it. If it has a discount and it should have a premium, congrats you found some market inefficiency (but now you’ve encountered the problem of everyone has to recognize that inefficiency if it’s going to play out in your benefit).

That’s my rant on valuation.

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