Scott’s Math
Just finished reading the Scott McNealy interview that was linked to from Slashdot. It is a somewhat informative look at his thinking. But he makes a the following suspect financial assertion:
Q: What about the people who bought (Sun stock) in 2000?
A: At 10 times revenues? Do the math. Do the math at 10 times revenues. There is no way to justify anything. Two times revenues implies 15 percent compound annual growth rate forever. Jack Welch did that for 20 years and went down in the hall of fame as the greatest CEO ever. So what does 10 times require? Do the math.
We can compare to where stocks were at the peak of the bubble but we have generated cash. I think we’ve got a really solid business.
Ignore the fact that ‘generating cash’ is enough to make a business ’solid’, regardless of how much capital it takes. And I am sure he is right that Sun was overvalued. I am interested in the assertion that the relationship between a company’s market value and their revenues implies something about its expected growth rate. Yes, a company’s stock price reflects a market consensus about the growth and riskiness of its profits, but which are the difference between its revenues and costs. So presumably McNealy’s analysis involved a fixing the costs relative to revenues. (A quick bit of Excel shows that he assumes margins of around 30%.) But why would investors believe that a company’s cost structure would remain unchanged as its market matures? This example seems to indict McNealy’s financial analysis more than his shareholders’.