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

by Aswath Damodaran

Relative valuation is more challenging with young firms that have little to show in terms of operations and face substantial risks in operations and threats to their existence, for the following reasons: Life cycle affects fundamentals: To the extent that we are comparing a young firm to more mature firms in the business, there are likely to be significant differences in risk, cash flows, and growth across the firms. Survival: A related point is that there is a high probability of failure in young firms. Firms that are mature and have a lower probability of failure should therefore trade at higher market values, for any given variable such as revenues, earnings, or book value, holding all else (growth and risk) constant. Scaling variable: Young firms often have very little revenues to show in the current year and many will be losing money; the book value is usually meaningless. Applying a multiple to any one of these measures will result in outlandish numbers. Liquidity: Since equity in publicly traded companies is often more liquid than equity in young growth companies, the value obtained by using these multiples may be too high if applied to a young company.