Howard recently wrote about the era of valuation compression we find ourselves in now. With inflation and rising rates, he suspects a lot more valuation compression in the public and private markets lie ahead. Howard notes smaller teams, capital efficiency, and a valuation that allows for optionality are required to move forward. And founders will have to start off with lower valuations and manage a new set of investor expectations as they navigate the era of valuation compression.
But we've been here before. As we're all faced with this new reality, I was reminded of a valuation story I heard from Jim O'Shaughnessy. If you're old enough, you probably caught the tongue-in-cheek reference to James and the Giant Peach. This is a peach of a story.
It’s one of those little gems that hits you in the face with a brick. You never forget it.
If you’ve ever bought a stock, chances are you did some sort of valuation; price to earnings, price to book, etc. If you’re crazy, you may have even consulted a chart; or an astrologist.
Jim’s parable brilliantly highlights how absurd we can be when it comes to the placing value on a business:
On his way to give a talk at Google, Jim comes across a gyro truck outside the venue. Gulping down what has to be the best gyro Jim has ever eaten, his business prowess senses opportunity.
Curious, Jim asks the guy his revenue.
“100k.” the man says.
“What would you want for the business?” Jim asks.
“Ten million dollars.”
The value investor in Jim takes a pass. The quant in Jim notes the correlation of good gyros and insanity.