A common question given during consulting interviews is the guesstimation question - e.g. how many ping-pong balls fit in a 747? Like many such questions, the point is not the answer but the process the candidate gives. For this one, one approach would be to start with the size of a ping pong ball, dimensions of the plane and make assumptions about the width of the wings.
Market-sizing is indeed a similar problem, and like most things in business are highly dependent on assumptions. For many of the high-flying momentum names (TSLA, FB, TWTR, FEYE, etc.), assumptions of a large market opportunity support the buyers (though I'd argue many supporters depend on price momentum more so). However, the does fast growth make a stock (and business) worth buying?
Most of the time, I don't think so because 1) psychology has shown that people are easily overoptimistic about future growth and so 2) the price for such businesses are highly expensive compared to normally valued businesses. What happens when momentum falters?
(Source)
Schadenfreude aside, many have asked what is driving the sell-off. I believe the better question is, why were these securities priced so highly in the first place? Take FireEye (FEYE) for example: it is a next generation IT security provider selling at nearly 20x ttm revenues and has a return on equity of -32.85%. Let's be clear, if you had actually invested capital/equity in the business seeking $ return from operations, you would have lost nearly a third of your capital in one year. Nevermind growth 5 years ahead, at this rate you will have no capital left!
When investors are valuing eyeballs (2000, 2014) and startups are having to cold-call journalists to sell ipo shares, it is hard to justifying buying.
Careful investing to all,
-Stanley
