Most obvious reason is that to be a successful public company you need to have two things. One is a "story". Why should an investor buy you? Companies have large investor relations budgets just to keep people up with this story. CFO's and CEO's tour the country and meet with investors daily for this reason. If you don't have a convincing story, you are going to pay for it with a low valuation. You can make good money, but if a competitor is perceived to have better growth rates or more dependable management, then you are going to lose the valuation game. Number two is that you need to have reliable management. This means when you tell Wall St. and the world something, you better live up to it. This has obviously gotten a lot of executives in trouble. Private companies don't have this concern, they just focus on being as profitable and successful as they want and they think they can handle. They don't make promises to anyone but themselves. However, should this company choose to go public, they have to change their thinking. Also it has negative valuation if the company is new and has unproven managers. The Street doesn't know if they will be reliable or not, they have no history. This is why spin-offs from established companies can tend to do better than IPO's that lack managers with a reputation. I read the survey about two years ago, it was about a 10% valuation difference. Problem is that this number is hard to say with certainty because you have to strip out a lot of details such as if the CFO was hired from a public company for this purpose, how much of the company's reputation is based on his performance at his other company and so forth. Bottom line, Ray is right there is a definite bias against private companies and their valuations, especially if they do eventually go public.


As for the question of paying for indexes, well its dependent on your view of future cash flow. Forget trailing EPS, that is about as useless a number that there is. Further I ignore EPS because EPS is a cooked number in far too many cases. If you read some analysts, they have gotten pretty keen on using DCF valuations for companies and that is the superior method. Estimate their net cash flow over a set period of time that you can make pretty good predictions about, say 5 years, and then assign a future growth rate past that and get a terminal valuation. That is a ton of work for indexes, certainly beyond the capability of an individual investor. Really its hard to put a specific price you should pay on a index for this reason. Still the lowering of interest rates and future inflation is crucial to increasing the value of all companies. Increasing productivity is even better for the indexes. These numbers, when they are positive, mean companies can add to their long-term growth rates fairly easily because their costs are close to flat, but their sales will increase as a function of the economy growing. From company to company, there can be fluctuations due to competition and product substitution, but over a broader index it tends to favor growth because the largest companies are generally gaining, not losing market share to smaller, non-index companies.