As part of the In our Metrics That Matter series, we've written about three analytics for tracking your path to profitability and two metrics for aligning retention and expansion. These metrics serve as both outputs and inputs. They are the result of the work of people at companies who work hard to create compelling products, distribute them to customers, and move their businesses forward. These are also inputs into valuations, a topic that is particularly relevant in today's market.
Two years have passed since the S&P hit an all-time high in January 2022. After a tumultuous 2022 and 2023, the S&P rebounded in November and is now nearing its all-time high again, with valuation multiples on track to recover. This is partly due to the rise of the Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) and investor optimism about the possibility of lower interest rates.
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Given the whiplash, founders, executives, investors, and analysts alike are wondering how they should think about valuations looking ahead to 2024.
Over the years, classic books on valuation have been widely praised and well-researched, but these guides can often run into hundreds (or thousands) of pages and overwhelm readers.
With that in mind, here are three practical observations about valuation for founders.
- Interest rates affect the valuation of public and private companies.
- Focus on sustainable, high-quality revenue growth.
- Valuation is determined by sentiment in the short term and fundamentals in the long term.
Interest rates affect the valuation of listed and private companies.
High performance coaches encourage their clients to “control the controllables.” Unfortunately, interest rates are not something you can control.
Founders, executives, investors, and analysts alike are wondering how to think about valuations as we look ahead to 2024.
The Federal Reserve sets monetary policy as a way to keep the prices of goods and services low and achieve stable inflation. When the Fed raises interest rates, it becomes more attractive for individuals to save rather than spend. The same goes for investors. If it is more profitable to invest in risk-free government bonds, investors expect higher returns when investing in risky stocks.
When it comes to valuations, public markets typically spend time discussing earnings multiples, or net income or profits. For example, a price-to-earnings (P/E) multiple of 20 means that a company with earnings of $1 per share is worth $20. A P/E ratio of 20x means an earnings yield of 5% (1/20). If a company has not yet announced earnings, analysts look at other metrics such as revenue, gross margin, and EBITDA.
As interest rates rise, multiples decrease as investors seek higher yields by investing in stocks rather than bonds. This can be seen by plotting the 10-year Treasury bill rate against his S&P futures P/E multiple.