What is it really?
Everyone leans on the price-to-earnings multiple, but it is never that simple. Simple to calculate, but not easy to get it right. Earnings are $250,000 per year and a P/E multiple of four means my business is worth a million. Sounds reasonable, right? Well, try selling it at that price and you will find that buyers will argue to reduce both the earnings number and the multiple.
If you look at public companies and the financial analysts’ valuations, you will find they disagree on both past earnings and the forecasts of future earnings, as well as the multiples to be applied. Why is Amazon currently valued by the market at 247 times current earnings and TD Bank at 13 times? (And your business at only three times?)
This is where everyone quotes Warren Buffet (so I’ll do the same). He looks for value based on the “sustainable competitive advantage” or “economic moat” which protects the business from its competitors. That value comes from the intangibles which support high expectations of future growth and low risk of losing market share to competitors or new entrants. Those intangibles include brand name, patent protection, customer loyalty, intellectual property, strategic relationships, creative and innovative organisations, a long history and a good reputation. Some investors and advisors, like the Motley Fool, insist that their best investments have been because of visionary leadership which has consistently seen new opportunities, adapted and delivered solutions. They are thinking of Steve Jobs at Apple, Jeff Bezos at Amazon, Elon Musk at Tesla and other visionary leaders.
So remember to look past the numbers and the simple calculations. Real value is driven by the things you cannot calculate, but you can evaluate. Use your imagination and make the leap of faith.
Be better. Do better.
Your Uncle Ralph, Del Chatterson
Join our mailing list at LearningEntrepreneurship.com for ideas, information and inspiration for entrepreneurs.
Read more articles at: Learning Entrepreneurship Blogs.
Click Here to check out Uncle Ralph’s books, "Don't Do It the Hard Way" and "The Complete Do-It-Yourself Guide to Business Plans" Both are available online or at your favourite bookstore in hard cover, paperback or e-book.