Hi,
I want to value a public limited company listed on NYSE which is in its growth stage, does not pay dividends and has negative cash flow. what valuation method should be used for such companies.
Nidhi Purohit
DCF
usually EBITDA multiples I believe. Valuation of early stage companies is more of an art than a science. You could try and estimate future cash flows but those would most certainly be unreliable.
You make up some future cash flows and discount. I do look to see if there are multiples that will work, but in these early companies, usually nope, because no earnings.
You have to use your judgment about what the earnings growth will be like in the growth stage (basically making it up with a best guess, as PA says), also how long that stage will be, and what normal growth is likely to be like once the growth phase is over.
If the company isn’t paying dividends, something like the residual income method could be used instead of your standard dividend discount model.
YW is also right that a lot of people just skip that step and use EBITDA comparables.
And what does an EBITDA multiple do? From my point of view all it does it put a multiple instead of an estimate of the future. I’d rather be explicit in my unreliable forecasts vs. them be implicit and unknowable via a multiple. The value of the asset is determined by how long it takes to generate free cash flow and how much it generates. No valuation is reliable, it’s just an easy way to avoid admitting that when we use multiples instead
I dont disagree with you, i wasnt sure how accurate of an estimate he needed. Back to my statement that valuing these companies is more of an art than a science, you have to have a much stronger understanding of the company and how it wants to look when mature to even begin to estimate future cash flows. Realistically you are essentially buying an option because so many of these companies will never pan out
Plus most discounted cash flow models still have that issue with a terminal value at some point in the future. The choices of how to deal with terminal value basically boil down to some kind of constant growth model (based on dividends or something like residual income growing at a constant rate), or use some kind of multiple (which is a lot more common).
So even with discounted cash flows, you can rarely get out of using either multiples or constant growth assumptions, both of which are known to be massive simplifications. Often the best way around this is to increase your discount rate in order to adjust for the risk of your assumptions being wrong.
Yea, multiples are common but its because they are easy. No idea why he’s asking, but my assumption (likely wrong) is that someone asking how to value something in the investment section of the CFA related forum wants something that conceptually sound. And multiples in terminal value is no different than skipping the DCF and using a multiple to me. Of course I’ll take my results and see what multiple they generate as a sanity check.
I suspect multiples work better for established, steady businesses. Seems like there is too much path variation in a startup money losing fund. Never tested that, but it seems like it would be true.
Sometimes I run the DCF out 30yrs (there are businesses where that is relevant/possible), and in doing so the TV (usually GGM) doesn’t really move NPV. But whatever time frame, I always model revenue in detail, NOT income statement prior year x 1.05 per year, but how the actual revenue occurs (widgets x volume).
Just recently I saw the opposite, big name IB who did a lazy 3yr model based on prior year revenue, then dropped in a TV, and discounted the whole mess using a 30% DR (in other words, we don’t know). Total crap any idiot off the street could do, and they probably charged an outrageous price.
30% discount rate? High beta illiquid company difficult to value?
If you are discounting like that, you don’t need great profit assumptions, because what matters more is if you have the power to force people to accept your price.
Also very curious what kind of business would you be able to project 30 years of cash flows in any meaningful way?
Numerous early stage venture capital type companies, inside a holding company, on each venture they figured like 50%-100% revenue growth for 3yrs with zero expenses, then TV, then 30% DR. In other words, meaningless numbers.
Without going into too much detail there are some companies where the legal life of the revenue producing assets is very long. It doesn’t even need to be steady, since if it’s that long it evens out over time.
Interesting I assumed it would be something like that, obviously those sorts of valuations would exist. Would certainly be one of the more interesting models