Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

Unicorns And Decacorns: Watch Out!

|Includes: CAT, DuPont de Nemours, Inc. (DD), F, FDX

In January 2014, there were 43 "unicorns" in the USA. Unicorns are private start-ups valued at $1 billion or more by venture capital firms. As of November 2015, that number had more than tripled to 131. Tech gurus use the term "decacorn" for companies valued at $10 billions or more. They have also more than tripled.

Although, traditional valuation methods don't apply to pre-IPO tech start-ups, so price is a lot more difficult to ascertain, it is legitimate to be skeptic about the unicorns valuations.

Start-up valuations are looking superficial. Pre-IPO high flyers such as Uber, Xiaomi, Airbnb, Palentir and Snapchat are seeing their valuations soar to the skies to as much as $51 billion, $46 billion, $26 billion, $20 billion and $ 16 billion respectively. As a comparison, Dow Chemical (NYSE:DOW) has a market capitalisation of $66 billion, Ford Motor (NYSE:F) of $56 billion, Fedex (NYSE:FDX) of $ 42 billion and Caterpillar (NYSE:CAT) of $ 39 billion, to name a few.

The table below presents the sudden proliferation of unicorns and decacorns.

Valuation as of

Year

Number of companies valued at $1 billion or more (Unicorns)

Number of unicorns valued at $10 billions or more (Decacorns)

% of unicorns valued at $10 billions or more (Decacorns)

January

2014

43

3

9%

April

2014

55

4

7%

July

2014

60

4

7%

October

2014

71

5

7%

December

2014

76

7

9%

January

2015

80

8

10%

April

2015

98

9

9%

July

2015

114

11

10%

October

2015

127

11

9%

November

2015

131

11

8%

Sources: Wall Street Journal and Dow Jones VentureSource.

This abrupt explosion of unicorns and decacorns raises three important questions:

A) Are the unicorns valuations getting so high-ceilinged that they warrant concern about their impact on the capital markets in general (like a bubble ready to blow up)? Are we beginning to see the signs of the first boom of the 1999 dot-com peak right before the crash?

B) Is the venture capital market currently developing its own bubble that could create a systemic risk that will extend to the stock exchanges? Conversely, actually, stocks traded on the stock exchanges are undervalued compared to their intrinsic value even for corporations with a wide moat; that is, firms with strong competitive advantages.

C) Will you be the sitting duck at the exit when the unicorns will quit the venture capital market for the stockmarket through an IPO? Don't forget that before you, the individual investor, institutional investors are asking, to participate in late-stage financing rounds, favourable terms such as "liquidation preferences", in which it is promised that they will get at least their money back and sometimes a guaranteed return on top. In other cases, institutional investors are offered "ratchets", in which they will receive extra shares in compensation if the firm's valuation is reduced when it lists on the stockmarket.

Actionable Advice:

Invest or stay invested in stocks with demonstrable competitive advantages that are stocks with a solid trend of returns on capital greater than their cost of capital. Never abandon seeking for concrete alphas. It is less risky to show your alpha generating skills this way.It will leave you sleep at night.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.