Guest Post: The Laugh Test

Today we have a contribution from Ari Kuchinsky, who writes about the stock market, technology and often the intersection of the two.  I thought this was a brilliant shortcut for the first-glance, initial evaluation of stocks.  Enjoy! – JB

***

The Laugh Test

What does it really mean when a company IPOs at a valuation of $2 billion? It is easy to get lost in the big numbers when we can’t visualize what it means. Using relative valuations can be a big help. I make it into a game.

Did you know that LinkedIn’s ($LNKD) market cap of $6.4B is greater than the $5.87B market cap of Southwest Airlines ($LUV)? Groupon’s ($GRPN) $10.89B valuation (down from $16.70B just a week ago) sounds even higher than it does in the abstract when you consider that Marriott’s ($MAR) market cap is $9.48B and Whole Foods ($WFM) is valued at $11.34B. Pandora’s ($P) $1.91B market cap feels really expensive when you consider it has approximately the same market cap as well known brands such as Wendy’s ($WEN) and Domino’s Pizza ($DPZ).

When I evaluate stocks for holding over a period of months or years, I use my market cap laugh test. I can eliminate a lot of overpriced stocks with it. It is especially helpful when a stock has fallen in value making us think that the stock is “cheap” and a “value play.” More often than not, after running the stock through the laugh test, it turns out to still be expensive.

I play the game comparing the relative valuation of well known companies and brands with  speculative companies and IPOs. For example, is it really probable that Pandora has a ton of upside potential when it already is valued as being worth as much as Wendy’s and Domino’s Pizza? While these are completely different businesses, it is hard to envision a company selling streaming music over the Internet being worth more than these well known fast food brands (think about what Pandora offers and think about Wendy’s locations everywhere). Even if I am completely wrong and don’t appreciate the long term value and growth of Pandora, it is hard to see it being worth more than streaming movie provider Netflix ($NFLX) ($3.70B) or satellite radio broadcaster Sirius XM Radio ($SIRI) ($6.99B). When I look at Pandora on a relative basis, the upside seems very limited when Netflix is only valued at $3.70B.  Pandora doesn’t pass my laugh test even after the big drop from its IPO price.

Next, fire up your browser and visit bankrate.com and creditcards.com. Spend about two minutes using each website.  Bankrate ($RATE), the owner of bankrate.com and creditcards.com, has a market cap of $1.6B. Is this the website of a $1.6B enterprise?  So what does $1.6B translate to in the current market? Brinker International ($EAT), the operator of Chili’s and Maggiano’s restaurants has a market cap of $1.8B. The Cheesecake Factory ($CAKE) has a market cap of $1.44B. Visualize all of those Chili’s locations side-by-side with the bankrate.com and creditcards.com websites. Chuckle chuckle.

Note: Market capitalization is based on prices the morning of November 23rd.

***

About Ari:

Ari has been watching stock prices since he bought one share of duPont in the fifth grade and has been a computer geek since he started visiting and running bulletin board systems (BBS) in the late 1980s. Professionally, Ari is a commercial real estate attorney in Austin, Texas and holds a law degree from Vanderbilt and a business degree from the University of Florida. The opinions expressed by Ari are in his personal capacity and are not associated with any other person or entity.

Follow Ari Kuchinsky on Twitter:  @arikuchinsky

 

 

Tags: , , , , , ,

This content, which contains security-related opinions and/or information, is provided for informational purposes only and should not be relied upon in any manner as professional advice, or an endorsement of any practices, products or services. There can be no guarantees or assurances that the views expressed here will be applicable for any particular facts or circumstances, and should not be relied upon in any manner. You should consult your own advisers as to legal, business, tax, and other related matters concerning any investment.

The commentary in this “post” (including any related blog, podcasts, videos, and social media) reflects the personal opinions, viewpoints, and analyses of the Ritholtz Wealth Management employees providing such comments, and should not be regarded the views of Ritholtz Wealth Management LLC. or its respective affiliates or as a description of advisory services provided by Ritholtz Wealth Management or performance returns of any Ritholtz Wealth Management Investments client.

References to any securities or digital assets, or performance data, are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others.

Wealthcast Media, an affiliate of Ritholtz Wealth Management, receives payment from various entities for advertisements in affiliated podcasts, blogs and emails. Inclusion of such advertisements does not constitute or imply endorsement, sponsorship or recommendation thereof, or any affiliation therewith, by the Content Creator or by Ritholtz Wealth Management or any of its employees. Investments in securities involve the risk of loss. For additional advertisement disclaimers see here: https://www.ritholtzwealth.com/advertising-disclaimers

Please see disclosures here.

What's been said:

Discussions found on the web
  1. Blue Coaster33 commented on Apr 20

    Souls in the Waves

    Very good Early morning, I just stopped in to visit your website and believed I would say I appreciated myself.

  2. tv online, online tv commented on Apr 24

    The Birch of the Shadow

    I believe there may be a few duplicates, but an exceedingly useful checklist! I’ve tweeted this. Numerous thanks for sharing!

  3. stream movies commented on Apr 24

    Third Flower

    My wife and that i have been now delighted that Albert could carry out his scientific studies because of the thoughts he had through your website. It really is on occasion perplexing to simply often be giving freely methods which some individuals might…

  4. free movie downloads commented on Apr 24

    Thorn of Girl

    Great details is usually observed on this online blogging site.

  5. water ionizers commented on Apr 25

    Healing’s Dragon

    to locate matters to improve my site!I suppose its ok to generate use of a few of your principles!!

  6. water purification systems commented on Apr 26

    Thorn of Girl

    Superb information and facts is usually identified on this world wide web web site.

  7. kangen commented on Apr 30

    Third Flower

    My wife and that i happen to be now delighted that Albert could carry out his reports as a result of the tips he had by way of your web page. It’s every so often perplexing to only always be giving away techniques which a number of people could have b…

  8. kangen water commented on May 01

    Thorn of Girl

    Great data could be observed on this net blogging site.

  9. Harold Jahn commented on Nov 14

    … [Trackback]

    […] Find More on to that Topic: thereformedbroker.com/2011/11/25/guest-post-the-laugh-test/ […]

  10. intelligent automation experts commented on Nov 28

    … [Trackback]

    […] Find More here to that Topic: thereformedbroker.com/2011/11/25/guest-post-the-laugh-test/ […]

  11. garage door track adjustment commented on Dec 05

    … [Trackback]

    […] Read More on on that Topic: thereformedbroker.com/2011/11/25/guest-post-the-laugh-test/ […]

  12. Functional Testing commented on Dec 20

    … [Trackback]

    […] Find More on that Topic: thereformedbroker.com/2011/11/25/guest-post-the-laugh-test/ […]

  13. rbc online login commented on Dec 20

    … [Trackback]

    […] Read More here to that Topic: thereformedbroker.com/2011/11/25/guest-post-the-laugh-test/ […]

  14. gambling commented on Dec 28

    … [Trackback]

    […] Find More on on that Topic: thereformedbroker.com/2011/11/25/guest-post-the-laugh-test/ […]