New Ventures Society


  Price to Earnings 


The other major basis for valuing shares is the ratio of price to earnings. The average company in the S&P earns about 10% return on investment. Hot stocks are a bit higher while the old base line industries are around 8%. This is reflected in the standard practice that a company will only invest in projects that promise a 30% return. After accounting for mistakes, management expenses and taxes they are left with about 10% on average. This return varies widely by industry and over time. (see references for recent industry values). Thus a company with a $10 book value would earn $1 per share.


A small business formed by its owners and nurtured to significant size over many years can be sold for between 5 and 10 times earnings. To sell a private company at a fair price can take some time just like a house, even up to a year. A large public company on the other hand has many shareholders who are constantly buying and selling the shares on the market as they need. Thus, in contrast, a block of shares in a large public company can be sold in minutes. This liquidity of their investment is its prime feature. This large number of owners results in a relatively high P/E ratio ( averaging around 20). Thus a stock market price of $20.


The stock market prices a stock at a multiple of earnings (see references).  S&P averages 20 P/E but it has ranged as low as 5 after WW1 (below actual cash in the bank) when everyone expected a Depression {which came in 1920 -- ended by 1921 because the old school Republicans fired most the government workers and cut back on expenses, something that the Progressives beginning with Hoover refused to do} to a high of 123 in 2009 when everyone expected a quick recovery after the Banking Fiasco - ably  assisted by market manipulation by the Plunge Protection Team. But in general we can expect a 20 P/E. with a higher value for greater ROIs (over the next 20 years the FED forecasts that it may drop to 15 as the Baby Boomer generation liquidates assets for retirement). Thus the $1 earnings give us a $20 stock.


So, in theory, the $10 investments by our members in an SEC Registered offering overnight becomes a $20 market price of the stock.  In practice selling the shares will depress the price, so the trick is to get the investors to hold on to their shares while the funds run up the price on limited stock availability. A variation of this occurs in an IPO (generally at least 5 times book value) where the Syndicate supports the offering price by manipulating the market in the 30 days after an offering (and the initial shareholders barred from selling) . (yes, this is legal, and disclosed in the prospectus which no one reads)


Note that as a non profit we are prohibited from distributing profits that we make to the members. Their total gains will come from investing in the companies we create.


Actual uses of the excess funds for the non profit beyond the creation of new ventures will be in supporting education and scientific causes that benefit the membership indirectly.


This variation in the valuation of Public and Private companies resulted in the 1960s in what was known as the Conglomerate Craze. A public company (with a P/E of around 30) would buy up private companies (valued around 5-10) by issuing new shares to the private owners. Since the company was buying assets on the cheap the earnings per share would jump with each purchase and thus the stock would skyrocket.


These mergers could be in many different industries under the idea that being a manager was universal and a good manager could run any business, vast experience not needed. In contrast some mergers were in the same industry. Service Corporation of America brought a large number of competing funeral homes under the same umbrella achieving economies of scale and providing a retirement route for the small businessmen. For a while these companies were the darlings of Wall Street because they were rapidly growing in earnings per share and thus worthy of sky high multiples. But eventually the rate of growth by merger faltered as it inevitably must. $1 of low value income added to $1 of high value income is spectacular on a percentage basis if the total shares are small - you have nearly doubled the stock. But $1 added to a $1 of high valued stock is unnoticeable when there are millions of shares outstanding. So the premium multiple dropped to the average rate or even lower because the idea that a grocer could step in to run a car parts company was a bit of a stretch.


In a similar manner before the consolidation of the banking industry eliminated most of the small town banks, forming a bank was a road to instant wealth. The government regulations required that a new bank have a diverse ownership and that all shareholders come in for a set dollar price per share. Since the regulators also set a limit on how big the banks capital would be, to get to buy shares was an instant profit. A shareholder could buy shares at the subscription price of $10 and see the share valued in the market at $30 overnight. The only limit on how much money he could make would be how many shares he could buy. The downside was that the business community expected him to hold those shares and not sell them, together with the knowledge that selling a large block would depress the price. The bank would then achieve a steady growth in income primarily due to the crazy accounting of how banks hide income and conceal losses and expenses in good and bad years through special reserves and losses accounts. The real
state of a bank can be hidden from the public until the regulators swoop down and declare it insolvent because of all the bad loans it made.


What will happen in the stock market is impossible to predict. From general trends some reactions can be anticipated. The average P/E ratio for large companies is 20. With new companies the valuation is usually based on future earning potential. A company with a loss or several years to achieve its potential is not valued at zero. In the case of Amazon where the company consistently has a negative income year the stock is given an extremely high price simply because the potential to take over the retail market is perceived.


In fact the venture capital industry values over 60 companies which have little or no income, and often no sales at over a billion dollars. (and which are not public companies with a real market price). It can be anticipated that the immediate market value would be between the $10 book value and the $20 average value once the earnings stream is present.