Prediction of future price should not be measure of value

By DAVID MOON, Moon Capital Management, LLC
May 29, 2011

The prices of assets move around for all sorts of reasons, including: emotions, news reports, advertising, competition and economic factors. If the asset is an investment asset, however, the value is a function of one thing: how much cash will the asset generate for its owner?

Plenty of people disagree with that concept, instead believing that the value of a thing depends on predictions about future price movements. That’s the only way you can justify the price of gold at $1500 an ounce. Of course, that doesn’t explain how, over the past 30 years, the price of an ounce of Hershey Bar has increased more than an ounce of gold.

Perhaps we should be piling up cases of Kit Kat bars in preparation for the collapse of the US dollar.

This emotional pricing phenomenon regularly repeats itself. I was reminded of that last week when the stock of business social networking company LinkedIn more than doubled the day following its initial public offering, trading at almost 600 times earnings. For a few minutes, the market valued LinkedIn at more than $11 billion.

The word valued in that previous sentence should be in quotation marks. Actually, quotation marks aren’t even strong enough to suggest how emotionally stupid investors were pricing LinkedIn that day. There should be some new, super-stupid suggestive punctuation mark.

Most of what I know about LinkedIn is that I get automatically generated emails from acquaintances asking me to join. These people are almost exclusively under the age of 30 and looking to change jobs.

So far, I have resisted the urge to join.

A dozen years ago, the mantra was that companies didn’t need earnings; all they needed were eyeballs. Or clicks. Or some other new measure of justifying sky-high valuations.

Many analysts at the time argued that price-to-earnings were irrelevant for technology companies, because they weren’t structured to create earnings; all of their excess revenue (assuming they had revenue) had to be reinvested back into new technology.

Most of those companies went away. Companies like Webvan, which was going to let you buy your groceries online and have them delivered like pizza. No earnings. No company. had one of the best web addresses of all time, yet the stock went to zero. Subprime auto lender BarNone paid $125,000 for the spokesthing, a sock puppet.

Social media is the new buzz phrase and Facebook is the model everyone seeks to replicate. But remember that Facebook was almost an accident, created to gain access to pictures of college girls. When the company publicly opened its site to all adult users in the fall of 2006, MySpace owned the social networking industry.

NewsCorp recently wrote down its investment in MySpace by $168 million.

If LinkedIn is too boring for you, how about combining two trendy popular emotional hot buttons? Renren is a Chinese social networking company. If it only offered a division that also owned (or at least purported to own) some gold bullion, we would have a hat trick.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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