Businesses are bought and sold every day. Day in and day out, people sell and buy businesses. They may retire, are tired of it, want to try something new, or the competition may be too much for them. Others have decided to work for themselves, and think they can do it profitably. There are franchised businesses, individually owned Mom and Pop stores, super markets, auto dealerships, hamburger stands, and hundreds of others. Every business gets sold and bought at one time or another, or merged into a larger one perhaps. How are businesses priced? Several ways.
The first consideration, is whether the business property is owned or not. If it is, and the selling price of the property is part of the sales price, the selling price will be appreciably higher, than if the store or place of business is leased. Most businesses lease their offices, stores, or places of operation.
The next part of business pricing, is its profits, or net. The gross, is the amount taken in. The net, is what is left after expenses. Some businesses have huge grosses. Many times, in the millions of dollars per year. This means nothing, if there is no “bottom line,” which means net profit. If a business takes in $25 million a year, and it has expenses of $26 million, it is bankrupt. If a small Mom and Pop corner grocery takes in $250,000 a year, and has expenses of only $200,000, they have a net of $50,000. In all probability, that business could be bought for $150,000.
I am reminded of the story of the fellow running a hot dog stand, and selling his hot dogs for 50 cents. His friend says to him, “Hey George, those hot dogs cost you 40 cents, the gas, bun, condiments, taxes, licenses, etc., cost you 15 cents, how do you think you are going to stay in business?” George answers, “I’ll make up for it in volume.” Stupid huh? Well, that kind of arithmetical calculation, is responsible for millions of bankruptcies each year. Large corporations juggle figures to make their performance look good, thereby making their stock go higher. Corporate finance can be extremely crooked, as witness Enron, and other bankruptcies, which cost stockholders hundreds of millions of dollars. A corporate indication of a stock’s value, is its “P/E ratio.” P/E stands for “price-earnings,” and is a pretty good indicator of a stock’s value. If a stock is priced at $100, and its P/E ratio is 10, that means the corporation earned a 10% profit. Profits may be plowed back in the corporation, at the whim or orders of the CEO, or board of directors. Stockholders may not get anything as a dividend, if the CEO or board decides the corporation need a new wazmatazz or fratasat, costing millions of dollars. The P/E ratio, is what counts in stocks, even if there are no dividends.
If a business grosses $1 million, and ends up with a $100,000 profit, it has made 10%, and technically has a P/E ratio of 10. Theoretically, that’s a fairly good business, assuming the owner don’t have to work a hundred hours a week, and have no time off. If a business has a long-term lease, so the rent won’t go up, and is well operated and profitable; what could be gotten for it? Let’s explore further.
Assume a business that sells and repairs whamadoodles. Whamadoodles have a hundred parts, and whenever a new model comes out, the manufacturer sees to it that parts for last year’s model won’t fit into this years model or so it seems. Lots of parts have to be on hand, so if the business is sold or bought, the parts and new whamadoodle inventory, as well as the business itself, will have to be considered. The customer base and good will, are called “blue sky.” (Wonder what I am coming to? Read on.) The business also has computers for keeping track of parts, customers, billings, accounts receivable, accounts payable, withholding taxes, etc. It has office furniture, possibly delivery trucks, fork lift trucks, packing equipment, and all that goes into a whamadoodle business. After all of that, it still makes a hundred thousand bucks a year. Could you sell or buy the business itself, not counting the property, equipment, and inventory, for $3,200,000? Not on your chinny chin chin. You might buy or sell it for $250,000 plus property, inventory, and equipment, but 32 times net? When pigs fly.
So here it is, making a pretty good profit, operates well, is secure, and whamadoodles will be around for a long time. The customer base is enlarging, and all looks good. So why can’t it be sold for $3,200,000 plus equipment and inventory? Why wouldn’t someone buy it for that price? Simply because the market will not bear it. Selling businesses, is very competitive. People wanting to go into business, always look at the figures, potential, and usually imagine they can do a better job, and improve the bottom line, or net. A person buying a business, would likely convince themselves that they could do it better than the current owner, and make more than he is making. It’s natural.
The “market,” sets the price of things. People wanting to go into business, are plentiful. Their abilities may not be very good, but there’s a lot of them looking, and this keeps prices down. Competition is the word.
Just about every business I have sold, has been bought by idiots, who promptly ruined them. They had the cash, so who was I to tell them what to do, or refuse to sell, because I thought they are fools? Just like stockbrokers, you might say. (Now we are getting there.) Here are businesses going for a decent price, and a person buying one can do well if they are smart, experienced, and have a bit of luck. Just like stocks. (We are there.) Why then, do people continue to buy stocks, whose latest average P/E ratios are 32? A P/E ratio of 32, means that the stock is priced at 32 times it earnings, (not dividends) and are three to four times their historic ratio, which would make them a terrible buy. The stock-broker, doesn’t usually care a whit about the client, but is interested in his commission for selling, just like the businessman selling his business. If the client wants to buy that over-priced stock, so be it.
If you bought that business for $3,200,000, (P/E ratio of 32 which is what stocks are now), it would take you 32 years to pay for it, and this is if you took no salary, nothing broke, and the market for whamadoodles remained steady. Foolish? Yup.
A stock’s P/E ratio of 10, means you may get a small check each year, and the corporation is making a go of it. Not a bad buy, perhaps. A P/E ratio of 32, means the stock is over-priced, and it’s just that simple. You’d be far better buying a business which is priced at ten times its net. Far better, but you can usually buy it for a lot less. If you own your own business, you do not suffer from fools that run corporations, and their ignorant boards of directors, which is usually the case. When you own your own, you make the decisions, and a business can often be bought for twice or three times its net, not ten times. That’s a P/E ratio of 2 or 3. In other words, stocks are generally a poor buy, as of this date.
Now look at gold and silver. There are few places in the world where silver can be mined for its current spot price. Maybe in China, using slave labor, but not many others. Silver is now being used to preserve lumber, and is being sprayed on hospital heat ducts, since bacteria cannot live on silver. If low, or non-resistance wire ever comes to pass, it’ll use thousands of tons of silver. Silver is used for multitudes of electrical products, computers, jewelry, and photographic film. Gold can be mined at its current spot price, but at not too many places. Then we get back into ratios again. Gold-Silver ratios are over 70 to 1, an enormous disparity, and totally unnatural. They should be 35 to 1, or even lower. They were 16 to 1 in 1980, and 16 to 1, for most of America’s history. Ratios are important, as far as stock buying, business buying, and precious metals buying. You wouldn’t buy a business with a P/E ratio of current stock prices. When you buy a share of stock, you are actually buying part of a business. If you wouldn’t buy an entire business with a P/E ratio of 32 to 1, and can usually buy one with a P/E ratio of as low as 2 or 3, why in the world would you buy into a business (stocks) with a ridiculous P/E ratio of 32? If you buy a stock, check the P/E ratios, which are not published in the newspapers. Protect yourself.