"The Pulse" -- #133 / Private & Public Market Returns

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Market Update:

Private vs. Public Markets

When people talk about investing, they usually mean public markets. Stocks, ETFs, indexes like the S&P 500. You open an app, buy a ticker, and you are in.

Private markets, meaning private equity and venture capital, are talked about more as an alternative asset class rather than something most individuals interact with day to day. Public and private market returns can look very different, especially during specific time periods, because of PE time horizons and the fact that their investments are not marked-to-market.

In good times, public and private markets do not look that different. Public equities have returned around 9 to 10 percent per year over long periods. Private equity funds like to advertise returns in mid to high teens. That sounds meaningfully better, but those numbers usually reflect top-performing funds, are reported before fees, and are smoothed over time. The differences become much more obvious during periods of stress.

Look at the 2008 financial crisis. Public markets got absolutely wrecked. The S&P 500 fell about 57 percent from peak to trough, and valuations collapsed fast. The forward P/E ratio dropped from roughly 16 or 17x in 2007 to around 10x in early 2009. Every bad headline showed up immediately in stock prices, so if you owned public equities, you felt it daily.

Private equity looked way calmer at the time. PE funds reported smaller drawdowns and less volatility, not because their companies were holding up better but mainly because of accounting. Private assets are valued way less frequently using models, not live prices, so losses showed up slowly. Many PE funds eventually marked assets down in the years after 2008.

The same pattern showed up during COVID. In March 2020, public markets dropped around 34 percent in a few weeks. Valuations moved fast again with the S&P 500 going from about 19x earnings before COVID to briefly lower, then shot above 22x by the end of 2020 once rates went to zero.

Private markets barely moved at first. Early COVID valuations in PE and VC looked solid then exits disappeared, fundraising slowed, and reality set in. By 2022 and 2023, many venture-backed companies saw effective valuation cuts of 30 to 70 percent, even if they avoided officially calling them down rounds.

The 2022 rate shock made the contrast even clearer. Public markets repriced immediately. The S&P 500 P/E fell from around 22x at the end of 2021 to about 16x by late 2022. Tech stocks were hit very hard and PE valuations stayed high on paper, but deal activity collapsed. Eventually, prices adjusted, but only after liquidity dried up.

Bottom line, public markets are brutally transparent. You see losses instantly, but prices also reset and recover faster. Private markets feel smoother, but that smoothness comes from delayed pricing and illiquidity. Over a full cycle, the economic reality is often similar. The difference is when and how you are forced to confront it.

Disclosure: Nothing written here is financial advice or should be used for investment decisions.

Comps & Precedent Transactions Analysis

Just covering the Big 3 of Valuation today.

-Comparable Companies Analysis-

Matching apples to apples.

At its core, comps analysis involves spreading financial metrics of very similar companies to determine how they match up against one another.

You're trying to value Company A: a U.S.-based cybersecurity, SAAS business with a $20bn enterprise value

To find good comps, you want to find as many SIMILAR businesses as possible (3-5) usually works. They should be similar in:

-Industry
-Business Model
-Size
-Geography

If you check those boxes, you'll spread some multiples such as EV / EBITDA, EV / Sales, and Debt / EBITDA to assess where Company A sits amongst peers

To arrive at a valuation, you'll take your median EV / EBITDA and apply it to Company A. This is your comps valuation!

-Precedent Transactions Analysis-

Easy one and similar to comps.

Let's revert back to valuing Company A. You want to see if there were any RECENT deals that involved the acquisition of a SIMILAR business by either:

a). a strategic buyer (typical operating company--usually a competitor)
or
b). a financial sponsor (PE firm)

The deal must be recent. Think the last 2-3 years to account for current market conditions

So, with precedent transactions you can arrive at a proxy for Company A's value by analyzing recent transactions of similar companies.

At the end of the day, valuation boils down to the number someone else is willing to pay for something.

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“The Pulse” #133