I haven't read the Portable MBA, but a proper valuation is based primarily on the expected future profit, adjusted for risk. Past/current profit can correlate with future profit, but is not the determining factor. It is too easy to 'fudge' profit in the short term. A better approach is to base a valuation primarily on a company's average return on invested capital. For example If a company spends $100 this year, that's $100 that won't be current profit. But it should return more than $100 in the future. In fact, a company might increase their value in the same year that they have a net loss. The reason for this is simple: A company's value is not how much money it earned in the past, but how much money it will earn in the future. How reliably can a company produce future earnings? And how much are those earnings expected to be? Those are the two fundamental questions to answer.
Comments
I haven't read the Portable MBA, but a proper valuation is based primarily on the expected future profit, adjusted for risk. Past/current profit can correlate with future profit, but is not the determining factor. It is too easy to 'fudge' profit in the short term. A better approach is to base a valuation primarily on a company's average return on invested capital. For example If a company spends $100 this year, that's $100 that won't be current profit. But it should return more than $100 in the future. In fact, a company might increase their value in the same year that they have a net loss. The reason for this is simple: A company's value is not how much money it earned in the past, but how much money it will earn in the future. How reliably can a company produce future earnings? And how much are those earnings expected to be? Those are the two fundamental questions to answer.