The Little Book of Valuation: How to Value a Company, Pick a Stock and Profit (Little Books. Big Profits)

by Aswath Damodaran

There are simple practices that can not only prevent egregious valuation errors but also lead to better valuations: Use forward revenues/earnings: Since young firms often have small revenues and negative earnings, one solution is to forecast the operating results of the firm further down the life cycle and use these forward revenues and earnings as the basis for valuation. In effect, we will estimate the value of the business in five years, using revenues or earnings from that point in time. While Evergreen Solar has revenues of only $90 million in the current year, it is projected to have $483 million in revenues in year 5. Adjust the multiple for the firm’s characteristics at the forward period: Consider a simple illustration. Assume that you have a company that is expected to have revenue growth of 50 percent for the next five years and 10 percent thereafter. The multiple that you apply to revenues or earnings in year five should reflect an expected growth rate of 10 percent (and not 50 percent). To estimate a value for Evergreen Solar in year five, we use 1.55, the multiple of revenues at which larger, mature firms in the sector trade at today. Adjust for time value and survival risk: When forward multiples are used to derive value, we need to adjust for the time value of money and the likelihood that the firm will not survive to get to the forward value. Incorporating the expected revenues for Evergreen Solar, applying the sector average multiple, and adjusting for th...