Eli5: How can large companies be worth (valued at) so much when they do not make any net profit?


Eli5: How can large companies be worth (valued at) so much when they do not make any net profit?

In: 7

Because they’re spending all the money they make to make themselves even more valuable.

If you started a business in your garage, and took all the money you made and bought land and a building to be your new headquarters, you’ve added assets to the company’s value while generating less profits (because you used the profits money to buy the stuff).

The company is more valuable though because it owns more stuff of value.

The evaluation also includes all assets including physical stuff the company owns as well as the value of intellectual property and patents the company holds.

* Lots of people will tell you it’s because there is the potential for profit (and thus dividend payments) in the future.
* But the real truth is because lots of investors know they can convince other people to buy their stock at a higher price.
* And the best way to get people to do that is to play along with the idea that companies that do *this* or *that* are very valuable and we should all buy stock in them.

If you are asking about the current situation with Twitter, and related companies then you are not the only one asking this question. Even experienced financial analyzers have no idea why some people think these companies are worth as much as they are.

But there are companies which are worth way more then what their net profit would have it. The idea is that while they might not be profitable now, and even run a huge loss, they are building up very valuable assets which will bring huge profits in the future. For social media sites their assets will typically be their brand and their users and network. And if this gets big enough you can make huge profits in advertisements, premium services and user data. So typically a company spend a lot of money in the startup phase, level off at the huge growth phase as they focus on growing as big as possible, and then make a lot of money when they can not grow any more and end up selling out.

The value of a firm is all of its future cash flows (cash in minus cash out) discounted to the present.

Getting to this value of course requires conjecture, and investors will disagree about what those future cash flows might be. Those who believe they will be higher will buy stock; those who think it will be lower will sell it. The balancing point between the two determines the price of the stock, and the price of stock * outstanding shares is the market valuation of the company.