07/10/2019
[What is your company (be it a loss-making start-up or an Internet behemoth) worth?] – ep.1
Start-ups are often valued using EV/GMV or GTV, EV/paying users, EV/revenue before their earnings become meaningful to investors and most people would agree that the applied multiples are more of an art than science (not to mention for some unicorns their multiple is applied on the run rate of the annualised operation metrics from the most recent quarter) and view relative valuation (P/Ex, P/Sx) being a different approach than DCF. This is a common misconception in secondary market among sell side analysts as well. Actually, Aswath Damodaran, a finance professor at New York University’s Stern School of Business, has made numerous excellent examples (eg. Uber) on how to value startups using DCF instead of blindly using multiples. In this series, we will try to discuss how should we relate the valuation methodology for listed Internet companies to startups with exponential growth, or even for listed companies, whether we should we use P/S, P/E, DCF or SOTP.
One should not view relative multiple as a different approach than DCF as the assumption you made in your multiple is embedded in your DCF, or the other way around. The value of any asset will always be the present value of its future cash flow, which is a function of the magnitude, timing and risk of the cash flows generated by the company. The multiple that you use on your company actually implies how you perceive your perpetual growth rate. For example, the steady state P/Ex of a company is 1/cost of equity, meaning that when the company fails to create value with its investment (even if it can continue to grow its earnings but its ROI on its reinvestment has failed to surpass its cost of equity), it only deserves to trade at a P/E multiple equal to the reciprocal of its cost of equity, also termed as the convergence formula.
