Technology businesses have very lucrative business models and are capital efficient because they do not require large investments. Many of these businesses operate in large markets and are consumer brands. All these factors lead to technology businesses having very high valuations.
Some of the most highly valued businesses in the world are technology businesses such as Amazon, Apple, Facebook, Microsoft, Google, Alibaba, among others. Facebook turned profitable in 2009, about five years after being founded. It already valued at USD 6.5 Bn by then and had raised hundreds of millions of dollars.
1. Valuation is determined by the return characteristics of the business’ cash flows and the uniqueness of the offering. The return characteristics are significantly dependent on growth of Earnings per Share (“EPS”) and Return on Equity (“RoE”). Many technology businesses have demonstrated that they after reaching steady state, they achieve rapid growth in EPS as well as high RoE.
2. Many technology businesses have very high addressable markets and so they have the ability scale up.
3. Technology businesses also need little fixed asset investments as they don’t need manufacturing plants to be setup. Much of their cost structure is operational in nature (like salaries, marketing, R&D). This further makes it easier for technology businesses to scale up.
4. In addition, technology businesses can become household brands further adding to their investment appeal as brands command a valuation premium in capital markets.
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