Crypto Investing #31 – How The Market Values A Stock Or A Cryptocurrency

Leon Fu: The way we can value this based on what the market value similar things. You can, one way to put a valuation on it is relative valuation. This in the stock market too

Tai Zen: So hey so let’s do an example of a stock that everyone is familiar with of how you do the valuation on that and then we’ll switch it over and do the one for Lisk. That way the audience knows what we’re talking about because remember if we talk about some they don’t know about them, it’s not gonna make any sense.

Leon Fu: All right, sorry, So let’s take an example of what’s a good example that everyone would know.

Let’s look at something that’s been traded for a while. Let’s look at Google. Google has been out for a while. So we know the concept of CE. We know the concept of price to earnings ratio. In the stock market, you hear about the PE is a statistic that’s quoted very common to quote it.

Tai Zen: I mean, I’ve never cared about that number when I’m trading.

Leon Fu: But it’s important. It’s the reason that you might not care about it because you just look at the charts. But from fundamental analysis, it tells you what investors are willing to pay for a company at any given moment. So if you look at price to earnings ratio tell what that number means is how many dollars are investors willing to pay for a dollar of earnings of that company.

Tai Zen: So if that company has a dollar’s worth of earnings and the price.

Leon Fu: How many dollars are investors willing to pay to get that dollar of earnings? So if you take a company say like a General Motors. That’s the company that the market values GM at 9. It gives it a PE of 9. Which means that the market is willing to pay $9 for every dollar of GM’s earnings. Or something like Caterpillar or something. That’s typically 9, 10. That’s 9, 10, 11, you know, 7, 8, 9, 10, 11. That’s something for like old-established traditional companies that actually like the multiple they get.

Tai Zen: So it’s about 9 out of 10 times earnings.

Leon Fu: So the stock price divided by the earnings you get to a multiple about 10.

Tai Zen: The listeners know what the average is so it’s around 10 and….

Leon Fu: I think like the S&P 500 trades or an average of 18 or something like that 15 to 18 for historically. I don’t know what it is right now but 15-18 like when we were at the peak of the bubble. It got as high as likely 5 and when you’re in like depression it can get down to like 9.

In the normal eye, we had a long term average tends to be around 15-18 something like that. So when Google came out in 2004 for I think it was they came out at a 50 multiple. In other words, the market was willing to pay $50 for every dollar of Google. And so the question you would ask yourself why is the market willing to pay $50 for $1 of Google’s earnings and only say $9-10 for $1, but it’s the same dollar. So why is it that for say a GM, the market is only willing to pay 10 but for a company like Google the market is willing to pay 50

Tai Zen: Because at that time they believed that it had more potential

Leon Fu: Well because that’s because some PE is looking at the past, the PE is looking at the way you calculate PE was for the past 12 months. How many dollars did you earn, the company earn per share, divided by the stock price. The stock price divided by the earnings for the last year. That’s a backward-looking number. It’s telling you what has been not what.

Tai Zen: It’s based on facts. It’s not based on opinion.

Leon Fu: It’s based on the facts that have already happened. That’s not how stocks to trade . Stocks trade based on what the market believes the future is going to be. Not based on what has already happened. It’s based on what the market thinks is going to happen.

Tai Zen: Like so when I’m trading, if you pull up a GE stock or a GM stock or Apple stock, I’m trading it based on where I expect it to be.

Leon Fu: Exactly. So the market is saying basically that I’m willing to pay $50 for a multiple of 50. Because the market believes Google is going to grow a lot faster than say at General Motors and in 2004 it actually did. In fact, if you paid 50 times earnings.

They said the forward multiple would actually from 2004 what actually ended up happening was you were actually only paying $6 for what happened in the future. Like there’s no way you could have known in 2004 but, you know, the next years you actually paid something like it was cheaper than anything like even paying 50 times earnings for Google was less than anything you could have bought. And that’s why Google has outperformed so much.

So that’s one way to look at valuations is you can say look at what is a multiple of, say Google or Facebook versus say a multiple of, you know, if you have like a company like Uber or any other tech company.

And so I have a friend who gave this example. He said “You know what? I can open a trucking company” like he’s trying to do something like Google for construction vehicles

Tai Zen: For like dump trucks and cement trucks

Leon Fu: Cement trucks to stuff like that. And he’s saying that you know, I could open a traditional cement or trucking company. And if I if let’s say I built this business and it makes a million dollars a year and I wanted to sell it I could probably only sell it for between $1,000,000-2,000,000.

If it made a million dollars a year and I want to sell the company I finally sell it for more than a few million dollars. But if I make a tech company, let’s say I make alike an Uber for dump trucks, a tech, a trucking tech company that is based around an app like Uber.

Because Uber is basically a taxi company. But they don’t own any taxis they just own an app. But if I built an, if I built like just as an app for dump trucks and I built this business that it made a million dollars a year just like I built a traditional company like that I could sell this company for $ 20, 000,000 not for 2 or 1.

And I would like why you get 1 and say like why would you be like, you know, you’re building basically a trucking company and just because this tech company has an app you could sell it for 20 times the profit versus if you just ran a regular.

But, you know, I’m saying if you just opened a little they made the same amount of money. You could only get two million for this for making the same amount of money. And I would like “Why is that?”. And he’s like “I don’t know why. That’s just what the market says”.

 

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