Buffett and Munger were effectively saying “we avoid more than just tech – we avoid anything (and everything) we don’t think we know better than most other people”
Twitter went public yesterday. It attracts much buzzes as well as soaring the share price more than 70% in its first day. So, what do you think about investing in Twitter, is it worth? Or, is this a new start of dot com bubble?
To me, the best thing I could have watch in television since MacGyver series is a reality show produced by BBC called Dragon’s Den. The show featuring entrepreneurs pitching their business ideas in order to secure investment finance from a panel of venture capitalists. This show was originated from Japan, but I watched Den first here via BBC Knowledge channel. In United States, this show called Shark Tank.
Okay, enough about shows. Watching reality shows surely fun. They are good time waster. But there’re more than that.
If you want to learn investment or stock investing or business in general, you have to watch these shows. I think it’s a better alternative if you couldn’t afford formal business school, or a way faster than reading dozen businesses/investing books.
As the entrepreneurs presented their pitches, we could learn which businesses are valuable compared to their offered value, the investment they asked investors to fund. The most important subject we learn is called business valuation. It’s a must have theory you should grasp before going into any investing thing.
How business valuation works? That show teaches us with simple explanation below.
Let’s say there’s a business that produced earning (NOT revenues) about $600,000 each year. This business needs more capital so they could improve earnings and growth more. Let’s say they need $1,000,000 (a million) capital so they could produce products for more wider market. They ask your money in exchange for a slice of equity in business, another word for owning that business. Let’s say the entrepreneur will give you 20% equity. Is this offer worth?
One simple way to valuing a business is using earning multiply. Ten earning multiply (read that as ten years of business running), is considered a fair and usable valuation. So, for a business producing $600k earning a year, it will produce about $6 million for ten years. Since they valued 20% of the company for $1 million investment, this mean they think the company worth as five times of that (100% divided by 20%), or about $5 million. Is $5 million company worth for a business producing about $6 million in ten years. The answer is yes.
Since you are a good businessman, you usually could turn that business producing much more earning faster under your cold hand. Thus you would consider the offer is a good business. You may able to make return on investment (read as taking your money back), in much shorter time—say, less than ten years. Later, you could think either to sell the business or going public, just as Twitter did yesterday.
That’s a simple explanation how investment works.
According Twitter’s numbers, for the last five years, they produced negative earnings year by year. Last year they loss $79 million, before that loss $128 million. What the number I say!! By seeing this numbers alone, I could quickly conclude this is not a company to me.
For a comparison, let’s look at Apple’s financials, last year they earned $37 billion, $41 billion by 2011, and $25 billion year before that. Year after year, investors in Apple would see their investment worth more because they produced something raising their value.
I use Twitter occasionally and I enjoy reading tweets, news, and greeting friends there. But I can’t believe investors think Twitter is worth more than Apple. Warren Buffet said he didn’t understand technology companies, that’s why he avoided their stocks (before IBM of course). In Buffet’s world, if you don’t understand enough, why would you invest? I think those dragons or sharks will say the same if Twitter entreprenuers pitching to them. I imagine they would say, “What are you doing for five years?”
Nuff said…. Not to say I am smarter than Wall Street fund managers. I am a UX designer and developer but I knew stock investment, tough little, more than five years now. I do manage my stocks investment by myself, and I have good confidence in my judgment, for my own. Just as Lynch taught me, you should invest in what you know. You should invest in an understandable business.
So, do you understand Twitter’s business? I hope it is not just a chirp thingy.
Disclaimer: this is not investment advice and I don’t own both Apple and Twitter stocks.