The Key Factors Determining the Value of a Public Company

When assessing the value of a public company, it is essential to understand the valuation, which is often derived from the current market price of its shares on the Initial Public Offering (IPO) day. However, there are several other important factors to consider when evaluating a company for investment purposes. In this article, we will delve into the three most critical factors: value, market interest, and future prospects.

Understanding Value: A Comprehensive Evaluation

The first crucial factor in evaluating a company is its value. This encompasses profitability, stock price, dividends, and the P/E ratio, which should be compared to market and industry standards. Additionally, a thorough examination of the balance sheet is necessary to ensure the company's financial health. These indicators provide a clear picture of the company's financial performance and stability.

Market Interest: Ownership and Market Perception

Market interest is another significant factor. A widely held or widely owned company by funds is generally viewed more favorably. The volatility of the company's price and its standing within the business and market sector also play a role. Understanding the level of market interest can provide insights into the company's ability to attract and retain investors.

Future Prospects: Long-Term Viability

The final factor to consider is the company's future prospects. This includes long-term viability as a company, short-term interest and volatility, and the competitive landscape. Moreover, the nature of the company's products and the public perception of the company also contribute to its overall value.

A Personal Journey: From Investing Novice to Businessman

As a young professional in my early 20s, I was drawn to the allure of the stock market. Inspired by stories of boy geniuses who made millions, I embarked on a path of self-education. I read books on day trading, conversed with Wall Street colleagues, and followed financial news on CNBC. Despite my efforts, I found it challenging to connect the dots and make sense of the ratios and financials. I lost thousands of dollars in the process, which felt like a devastating blow at the time. However, it was through my experiences running my own company that I truly understood what makes a company great.

Warren Buffett succinctly captured the essence of the relationship between running a business and investing when he stated, "I am a better investor because I am a businessman, and a better businessman because I am an investor."

Many entrepreneurs are drawn to vanity metrics, such as revenue growth, which led to the rise of the unicorn boom. However, it was the write-down of unicorn investments by Fidelity that prompted the broader question: how do you measure the value of a company?

The Importance of Free Cash Flow

The critical insight is that there is only one thing that matters in valuing a company: free cash flow. Free cash flow represents the cash that a company can generate after laying out the money required to maintain or expand its asset base. It is a crucial metric because it allows a company to pursue opportunities that enhance shareholder value.

Free cash flow is essentially the money a company has left over after it pays its bills. It is the leftover amount of the money the business has collected, after all expenses have been paid. To calculate free cash flow, you should sum up everything that comes in and subtract everything that goes out. The leftover amount is the free cash flow.

Connecting the Dots to the Value of Your Company

The value or worth of your company is essentially the market's belief in your ability to increase the company's assets. To achieve this, you can invest the free cash to build new products, acquire another company, or repurchase stocks. This is the money you can use to make more money for the business, which is what a business exists to do.

Hence, the greater a company's ability to generate free cash, the higher its valuation.