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Jason Ogaard: Valuing internet companies

There are a lot of ways to value a company.

Companies have revenue, profit, assets, percentage of markets, brand recognition, brand value, future potential etc. A lot of these things are easy to calculate and factor in. A few are more difficult. When looking at a company like GE an investor would likely use hard numbers to determine if they’re going to increase in value. When looking at a technology company, specifically one that deals with the internet, fuzzy math can apply.

In the late ’90s there was an economic bubble centered around the technology sector. There were all sorts of technology companies selling stock at high values. These values weren’t real, and the companies were wasting the cash that they earned with the stock. They were poorly managed and as a result many of them don’t exist today. The resulting crash made investors wary about technology companies.

A little more than nine years ago an internet search company named Google filed for an Initial Public Offering. The initial price of $85 put the value of Google at more than $23 billion. Today Googles stock price is more than $1000 and they’re valued at over $338 billion. Google was the first well known technology company to file for an IPO since the crash. Google has a business model that works and they don’t waste their money. Google makes most of their money by selling ads. They sell these ads by collecting data about their users and then show ads based on the users interests. The more interested the user is the more likely they’ll be to click on an ad.

Since the Google IPO a few other technology companies have gone public, the most well known being Facebook. Facebook’s value is a bit surprising to me though. Their earnings are roughly 1/8 that of Googles earnings yet Facebook is valued roughly 1/3 of Google at just over $126 billion. Shouldn’t Facebook be valued at roughly 1/8 of Google instead of 1/3? You could say that Facebook is overvalued right now. But let’s look at some reasons investors might have for Facebook’s ‘inflated’ value.

Facebook makes most of their money from ads too. Facebook does the same thing as Google by targeting ads based on your interests. However, in the case of Facebook, they have much better data than Google. Facebook literally has a list of your interests. They know where you go on vacation, they know where you eat, they know who your friends are, and on and on. Facebook should have revenue at least similar to Google because they know more about you. Facebook is doing a bad job of selling ads.

Facebook is being valued based on their future potential. Investors are hoping that they will find a way to sell ads that will earn Facebook revenues similar to Google. Facebook wasn’t always valued so high. Their stock price was half of what it is now not long ago. When Facebook first IPO’d their stock price dropped quite a bit and stayed low for a long time. It’s not been until recently that the stock price has exceeded the IPO price.

Another internet company is getting ready for their own IPO. Twitter is going to sell a limited percentage of their shares to the public. Twitter doesn’t have as many users or as much revenue as Facebook. Twitter executives also seem to want to avoid the same issues that plagued the Facebook IPO. Based on the initial asking price and number of total shares Twitter is going to ask for an initial value of over $12 billion. That puts them at 10% the value of Facebook. Twitter also has the same problem Facebook does though. They have users on the site all the time but how do they sell ads? Twitters revenue should be higher based on how many users they have.

I’m not suggesting you invest in these companies. I’m certainly no economic or investment guru. I’m merely find the way some companies are valued interesting. Using metrics such as future potential is a lot more risky because no one knows if Facebook or Twitter will be able to capitalize on their user base. The reward can be great though. Facebook doubled in price recently, who knows what will happen?

JASON OGAARD was born in Bemidji and is a software engineer for FICO, a Minneapolis based public company providing analytics and decision-making services, including credit scoring credit bureaus.