Financial Analysts Journal 20 March 2020 Volume 76 Issue 2
The Big Market Delusion: Valuation and Investment Implications
Big markets draw in entrepreneurs and VCs, overconfident that they can conquer these markets, which leads to a collective overpricing and an inevitable correction. We look at examples (e-commerce, online advertising, and cannabis) and implications.
In entrepreneurs’ minds, big markets offer the promise of easily scalable revenues that, coupled with profitability, can translate into large profits. This article examines how the “big market promise” affects business formation and financing, with a focus on the role of overconfidence on the part of both entrepreneurs and their financiers (venture capitalists and public equity) in creating a collective overpricing of companies in alleged big markets—and an inevitable correction. Three case studies illustrate this thesis—one in which the process has fully played out (1990s dot-com retail), one in which it has been unfolding for a while (online advertising), and one in which it is just beginning (the cannabis market). We suggest several lessons for investors, regulators, and businesses based on these case studies.
About the Author(s)
Bradford Cornell is a professor emeritus of finance at the UCLA Anderson School of Management, Westwood, California.
Aswath Damodaran is the Kerschner Family Chair Professor of Finance at the Stern School of Business at New York University, where he teaches corporate finance and valuation to MBAs, executives, and practitioners. He is the author of five books on valuation, three books on corporate finance, and three books on portfolio management, and he was co-editor of the book Investment Management with Peter Bernstein. Professor Damodaran has published articles in a number of journals, including the Journal of Financial and Quantitative Analysis and the Journal of Finance. He was named the most popular US business school professor in a 2011 survey by Businessweek. Professor Damodaran also writes a popular blog, Musings on Markets. He holds an MBA and a PhD from the University of California, Los Angeles.