What Apple, Amazon & Google Can Teach Startup Founders about Valuation

The Story of Three Stocks

If you follow the stock market, some interesting stock price dynamics might have caught your eye recently. Specifically, after second quarter earnings were posted, three companies experienced somewhat unexpected results: Amazon and Google stocks hit all-time highs, while Apple’s fell by a smaller margin.

At first glance, those shifts don’t make much sense.

After all, Apple’s quarterly earnings report dwarfed those published by Google and Amazon. In fact, Apple’s net income ($10.7 billion) was nearly 3x Google’s ($3.9 billion) and 116x Amazon’s ($92 million), and its revenue gains (33%) blew Amazon (20%) and Google (11%) out of the water. The discrepancy between the three companies’ stock price becomes even more confusing when you look at their price-to-earnings ratio (a widely used metric for assessing how much an investor must pay to receive $1 in earnings).

Amazon’s forward P/E is 450, Google’s is 29, and Apple’s is 14. For context, the S&P 500’s average P/E ratio is 21, which makes Apple look like a relative bargain. It also means Amazon investors are paying 32x more than Apple shareholders to receive the same earnings.

So, what gives?

Ultimately, there are numerous metrics and financial figures that factor into stock price, but the very high-level justification for Amazon and Google’s gains — and Apple’s fall — is fairly simple: Stock price is a reflection of future potential, not past results. Consequently, the majority of investors are more interested in what a company will look like in a year than what it looked like last year. Last week’s reports simply showed that investors are gaining confidence in Amazon and, to a lesser extent, Google, and are losing confidence in Apple’s ability to stay atop its lofty perch.

The Key Similarity Between Public Stock Prices and Private Valuations

It might take years to find out if investors’ bet on Amazon is an intelligent one, but one thing is clear: The ways in which a public market growth investor values a business isn’t much different than how a growth investor in the private markets (angels, VCs, private equity funds, etc.) project value on startups. Like public investors, we leverage a variety of data points to make educated bets on the future.

This helps explain how a consumer startup like Snapchat can be valued at $16 billion despite generating very little revenue and not yet recording a profit. Based on past financial performance, the business is worth very little. But based on future potential to generate revenue and profit, the business could prove to be worth much more than $16 billion (see: Facebook).

The same is true of Amazon.

While it might sound absurd to celebrate the fact that the business generated just $92 million in profit in Q2 on $23.19 billion in revenue, those numbers are somewhat irrelevant to investors betting on the future value of the company. What is relevant is the very real possibility that Amazon could eventually become the world’s biggest retailer, grocer, cloud computing provider, etc. The same can’t be said of Wal-Mart, which was just passed by Amazon as the world’s biggest retailer by market value despite generating more gross profit in Q2 ($30B) than Amazon generated in gross revenue ($23B).

What Tech Founders Can Learn from Public Market Dynamics

At the end of the day, valuations — whether they’re public or private — are an educated guessing game. As investors, we buy and sell based on the likelihood that a company will grow into a very big, very powerful enterprise.

Now, that’s not to say we’re always right (in fact, investors often fail more than they succeed). And it’s not to say your company’s current financial metrics don’t matter (they do — particularly if you’re a B2B SaaS startup). Rather, the key takeaway for founders is that the best way to optimize value for all shareholders — themselves, their employees, prospective investors, etc. — is to architect a growth strategy that helps people envision an incredible future.

That might mean rapidly acquiring users with the promise of monetization and profitability in the future, or it might mean optimizing your margins and financial health today so that it becomes difficult for other companies to compete as you grow. Regardless of the approach that makes the most sense for your type of business, the idea should be to build with one eye toward real performance today (acquiring more of your best customers/users), and one eye toward prospective opportunities in the future (identifying new markets, new customer segments, new partnerships, etc.).

Do that and you’ll stand a better chance of becoming your market’s Amazon — a business with such massive future potential that investors are happy to pay a huge price today for the promise of even bigger returns down the line.