Value is like Traffic

Bear with me for a second...


Imagine stocks of individual companies as lanes, on our many highways, city streets and urban areas.


Now imagine value as the utility we get from using the roads, empty roads obviously yield high utility as no one is stopping us from using the roads. We go where we need to, no stops or traffic and thus our utility is maximized.
Conversely if we look at a road which is littered with cars, bumper to bumper traffic and possibly a few accidents we see utility being minimized as we cannot use the roads for what they are meant for - travel.

Back to finance - as more and more people demand a certain share (or lane), traffic ensues and value (utility) is diminished as this demand rises the share price, often creating asset bubbles or even industry bubbles(traffic - in my opinion).
This is commonly seen today, where companies in the social networking industry are suddenly listing for IPO's and are doubling their listing price in days (or even hours).
Lets take Linkedin for example, going public on the 19th May 2011. Listing at $45 a share, climbed to $122 in a single day. It must be said, the share price did stabilize and is currently trading at $86.40 BUT.... looking deeper we see a PE ratio of 2375.31 - utterly ridiculous!
Even still many of the major banks in the USA are recommending "BUY" signals for Linkedin- and they arent the only ones.

The Wall Street Journal reported today "Facebook shares have traded on private-company exchanges  valuing the company at $70 billion to $80 billion".


To put that in perspective, 'Seeking Alpha' reported, when Goldman Sachs valued Facebook at $50 billion, "Giving Facebook that valuation puts it amoungst the likes of American Express, Kraft, and Boeing".

Facebook had $1.2 billion in revenue for the first nine months of 2010, resulting in $355 million net income, At Facebook's current $50 billion valuation, that puts its Price to Earnings Ratio greater than 100. That is insanely high.
A feeble argument that come into existence regarding these outrageous valuations include exponential earnings growth however;


If we consider the high level of technological development and current increased capital mobility within financial markets, and according to the World Bank global growth is projected to ease from 3.8 percent in 2010 to 3.2 percent in 2011, before picking up to 3.6 percent in each of 2012 and 2013, can we really assume that growth in earnings is really going to be that high? And even if growth does pick up, with Africa the only untapped market, why don't we think about market saturation or in fact global saturation.
Innovation is key to growth, but can we really price future innovation into a share price? If so, I don't believe its worth what some people are paying today.

The Young Economist