Residual Income Model and significant deficit

I am not sure whether this is the correct section for this particular question, but I will give it a shot anyway.

According to the residual income valuation model, the value of a security is the current value of equity less equity charge, which is calculated as the t-1 period book value times the cost of equity. So far so good. However, imagine the equity is strinking due to recurring net losses that are expected to continue for another 3-4 years. In such instance, the equity charge will be smaller than otherwise as the negative residual value will depress the book value of equity:

My question is, do I stick to this methodology or should I account for the accummulated deficit somehow? Is there a better way to value a distressed/immature company? I was thinking of valuing it through options but then the mean and standard deviation of the model would have been extremely arbitrary.

Thanks!

If your producing net losses your destroying value, your book value would be shirinking, I dont see anything inconsistent with the model at that point. FCF model might be a better choice htough

Thanks for the answer. I went for the residual income one as it is a growing company and it is unlikely to see any free cash flow in foreseenable future. In addition, it is an unique product/first of the kind, so mutiplies are not an option either. Apart from the RI, only the option pricing/montecarlo seem reasonable. The inputs, however, are quite limited to go for a statistically-heavy model.

If FCF model wont work as the company is in its infancy I dont see how an RI model would make much sense as its pouring in losses. I dont have much experience in young companies as it seems more like an art than a science, you basically are dealing with an option as you have no clue if the company will be able to execute as planned and it may never turn a profit.

Could look for other firms in the industy that are relatively similar and look at EBITDA multiples when they were young as well.

Any DCF model for a company without stable cash generation is moot imo, much better to have a qualitative perspective about the company and look at some type of multiple based approach.

A residual income model doens’t work if the residual income is negative. The model should show the company has negative worth.

Use comparable company analysis, your model will heavily rely on your own set of assumptions.

Considering your input and the specifics of the data I am working with, I decided to go for DFCF instead of RI, as it will better reflect the burning rate for the upcoming years.

I order to account for the expected dilution of secondary public offering, I decided use the projected number of shares rather than the actual shares outstanding when calculating the intrinsic value of the company.

I strongly prefer absolute over relative valuation as the company lacks listed competitors and is first-mover.