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Company Valuator

An exclusive monthly news report for private company CEO's
June 1, 2005
Sign of the Times
Did You Know
Ask the Expert
Market Stats
Helpful Links
Quote of the Month:

"I'm not a paranoid deranged millionaire. Dammit, I'm a billionaire."

????????? ---Howard Hughes

Sign of the Times

A monthly market commentary

“The Power of Long-term Compounding”

We all know the story of the Indians selling the island of Manhattan in 1626 for $24. In other words, for what it would cost to order a bagel and cafe latte at a midtown NYC hotel today, the Dutchman Peter Minuit owned the entire Big Apple.

While there are many outside of Gotham that would look at neither as a bargain, the point is to demonstrate the power of compound interest over time. Compound interest has been called the "eighth wonder of the world" and, with the help of the "ninth wonder of the world," the HP 12C, we can calculate whether Peter Minuit got a good deal or not.

Obviously, the key variable to determine the answer is the interest rate we apply to the $24. Or what we could have earned as an alternative investment.

The difference between a 5% return and a 10% return isn't a simple doubling but a compounding that becomes staggering over time. If the $24 was invested at 5% interest over the past 377 years it would have grown to $2.3 billion today, implying a good price given Rockefeller Center sold for $1.9 billion in 2000.

At a 10% return however, the $24 doesn't just double the 5% reuturn, or to $4.6 billion, but magnifies it to $97 quadrillion! The total U.S. Market Capitalization is $15.5 quadrillion.

In the world of investing, few stocks have accomplished the returns of Peter Minuit, yet, consider that Microsoft went from a $500 million market cap company at the time of its IPO to nearly $300 billion today by growing its earnings at approximately a 40% compound annual growth rate over the past 17 years.

The trick, of course, is that it is almost impossible to grow at a rate that high, for that long of a period, as the laws of compounding cause growth to diminish with size. Bearing this out is the fact that there are fewer than 30 companies that managed to grow their earnings in excess of 20% annually during the past 10 years--out of a universe of more than 12,000 companies!

Did You Know

“Rule of 72”

If without a HP 12C or to impress friends with math tricks, knowing the Rule of 72 is handy. What the Rule of 72 says is that if you divide an interest rate into 72, it will tell you how many years it will take to double your investment. At 9% interest, a dollar would double in 8 years. (72 divided by 9 = 8). At 12% interest a dollar would double in six years. Another way to look at it is that a company growing its earnings at 15% a year, with a constant P/E, will double its share price in approximately five years; a company growing its earnings at 25% per year with a constant P/E will double its value in approximately three years.

Ask the Expert

“One Cent Doubling Every Day or $10,000 per Week ??”

To illustrate the power of the doubling effect, suppose you were offered a job as a consultant for a month and you have had your choice of being paid $10,000 per week or a penny the first day, and having it double every day for the remainder of the month. Easy choice right?

At $10,000 per week, you would make $40,000 for the month. On the other hand, making a penny the first day, two cents the second, four cents the third, eight cents the fourth, and so on, you actually end up making over $10 million by the 31st day.

Market Stats

“Smaller Companies Cash In...”

In general, smaller companies on the low end range of the middle market are harder to sell because they can be just as?difficult?and expensive to integrate as a larger company.

The recent sellers market in larger companies has had a trickle down effect on smaller companies as acquiring companies?and private equity groups are in a unique position of having available cash to invest and debt financing available at low rates. This is good news for the lower end of the market but nothing lasts forever.

Experts expect the current M&A boom to last for awhile, but a huge number of baby boomers are on the verge of retirement; one out of every 2 business owners plans to sell their business in the next 10 years possibly creating a glut in the market that could?drive valuations downward and giving new leverage to buyers.

The chart below details the most active sectors during the past 12 months for these smaller companies:

Industry Name No. of Deals Avg. Price* (mm)
Computer Products & Services 948 $19.0
Miscellaneous Services 644 $18.9
Financial Services 286 $24.8
Wholesale & Distribution 244 $16.9
Leisure & Entertainment 232 $24.1
Insurance 220 $23.0
Construction & Engineering 218 $17.0
Retail 190 $12.7
Communications 164 $16.2
Printing & Publishing 160 $22.2
Banking & Services 152 $28.1
Health Services 133 $19.5

Helpful Links

Regardless of who makes your dinner reservations, nothing is more disappointing than hearing the available times at your chosen restaurant, for your special occasion,?just happens to be?5:30PM or 10PM. Of course, this is often because of a last minute decision to eat out, or worse, you remembered on February 13th you forgot to make a dinner reservation for Valentines Day!

A great way to see what is available at a number of restaurants is to make your reservations at? ?. Trust me, you cannot go wrong here. Open Table got their start in San Francisco and has almost all of the better restaurants on board in the bay area. The beauty of this is that you can make reservations 24 hours a day at no cost (yes, it's free) and avoid having to deal with all the hassles that are associated with calling the restaurant itself. Want a certain table or window view? Just make the request when you make the reservation and it will be noted. You can also invite friends, business associates or that "special person" via an email Open Table will send to whomever you designate. This is very cool stuff. Even the venerable French Laundry in the Napa?Valley has signed on.?TIP: It is quite possible to secure a reservation at a "hot spot"?that might initially be unavailable if you continue to check back. As an example, if I have?a reservation at?"Slanted Door" in SF?on Saturday night at 8PM and I decide to cancel, it will immediately open up that table for another party.?I tried it and it works. So, if you?or someone you designate can continue to check back with an otherwise unavailable restaurant,?you just might get your table--without ever having to pick up the phone--and, as if all of the above is not enough--you get points you can later redeem for dollars at your favorite restaurant. It's true. Open Table should be paying me for this....


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