Comment by dragonwriter | Hacker News Reader

Comment by dragonwriter | Hacker News Reader

The idea that market cap (current marginal stock price × total outstanding shares) is valuation is, well, convenient to get an easy way to calculate a number and call it the overall valuation, but doesn't really hold up.

All this article does is point out that if you use that (flawed) method to value Yahoo, and then use the same method to value Yahoo Japan, and then use even less-reliable means to value the non-public Alibaba, and then subtract the last two from the first, you get an unexpected number.

And even if the assumptions underlying the "negative" valuation of the core business were inassailable, its quite easy to have a business to have a negative $10 billion value. Suppose a business has $11 billion in total liabilities, and $1 billion is total assets. Voila, Owner's Equity is -$10 billion.

And this can still be a profitable company. Obviously, making profits means that profit stream has a value (the current value of the stream of future income), but that doesn't mean that you don't have liabilities that exceed that (and the valuation of that stream is not just based on current profit, but expectation of its future continuation. A company can be profitable but the market can lack confidence that it will continue to be profitable.)

actually, market cap === valuation

FYI, valuation is defined as enterprise value, not market cap. And in general, things like liquidity discounts and control premia also mean market cap is a poor proxy for acual or fungible value, even for the equity. The reason is that the marginal price of the equity is not the average price (in terms of market depth). simply multiplying a market that is 1-2% deep @ p=X x 100% of shares outstanding is flawed from the perspective of suplly and demand. these comments are made by others in the thread elsewhere, but worth repeating.

Enterprise value is an M&A metric. As an equity holder, equity value is the valuation of concern. Market cap is generally the best estimator of equity value.

Takeover value, equity value in the event someone wants to own all (or a controlling part of) the equity, is a different beast. It includes the strategic optionality that comes with owning a company. Having to take what management doles out thus produces a different equity value than takeover value. Market cap is the best estimate of this passive investor's equity value.

Isn't that the efficient market hypothesis ?

Which, when you read it, I'm sure you can come up with 10 counterexamples (obvious counterexample: ponzi schemes). I guess you could call me a disbeliever.

Value is what the market is willing to pay for it--for anything, not just companies. The EMH says that that value is always discounted perfectly on a risk-adjusted basis of all current knowledge about the company. Therefore if a company exceeds its risk adjusted expected performance in the future, it wouldn't be possible to predict beforehand.

That might technically be what the word means, but the implication is that this is what the company as a whole is worth, and that's not necessarily true.

A stock's price is essentially the first derivative (in calculus terms) of the company's value. Market cap is essentially assuming that the entire thing is linear, by taking the derivative and multiplying it by the total size. Stocks don't behave linearly, so this assumption isn't particularly good.

No, market cap = # of shares * last traded price. It's what the last bozo believed the value was, which varies widely depending on the bozo. Then you have the bozos who are trying to guess what the other bozos will do. At some point the market cap will be right, but only for an instant.

Doesn't a company with less assets than liabilities have to enter bankruptcy even if it's profitable? e.g. Mt Gox

You usually enter bankruptcy when you become insolvent, that is to say when you can't pay your bills (it can be the salaries of your employees, a bill from a supplier, debt interests, rent, utility bills, etc.). You can run a profitable business and go bankruptcy because you are out of cash, and nobody agrees to lend you some.

This is not unlikely when you have to pay your suppliers before you collect payments from your customers. And realistically that's the common case, not the exception. This is why cash flow is so important for any business.

Not necessarily. Generally, firms become insolvent if they can't meet their liabilities as they fall due (things get a bit more complicated for regulated firms such as insurers, which also have to worry about solvency ratios). If a firm's current liabilities exceed its current assets (where 'current' is defined as 'to be received/fall due in the next 12 months') then it's likely to be in trouble. Examples of current assets are cash, stock and trade debtors (i.e. other firms you have supplied to on credit), and current liabilities include trade creditors (firms who have supplied you on credit). These contrast with fixed assets and long-term liabilities, which aren't expected to arise for over 12 months (e.g. a 5 year bank loan).

If firms automatically became insolvent when liabilities exceeded assets, then no one would ever be able to start a firm with a bank loan, because from day one the liabilities (loan + interest) would outstrip the assets (cash).

It's also possible for a firm to have assets which exceed liabilities but still be insolvent, for example a property company with large fixed assets but little cash in the bank to meet its running costs.

Thanks, that clears it up.

> Doesn't a company with less assets than liabilities have to enter bankruptcy even if it's profitable?

No. A company is at risk of being forced into involuntary bankruptcy when it cannot meet its current obligations, which is different than having less assets than liabilities; but even when insolvent it doesn't have to enter bankruptcy, though its creditors can force it to do so (and, if it is profitable and expected to remain so, its creditors might not want to force it into bankruptcy, because they may expect the liabilities to be more fully paid, if delayed, if the firm remains in operation vs. bankruptcy.)

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