When you say “the stock is trading at 20x revenues” people rightly shake their head and say “that is nuts.” I got a lot of tweets like that in reaction to my comments about the Uber valuation in the LeWeb breakfast chat.
However, what people fail to realize is these things happen in a moment in time and that stocks won’t trade at 20x revenues forever.
Let’s take a fictional company that has $1bn in revenues in 2014 and goes public at $20bn, 20x revenues. Let’s say it will double revenues in 2015, then grow 60% in 2016, and 40% in 2017, and 30% in 2018.
So here are the revenue numbers
| (000s) | 2014 | 2015 | 2016 | 2017 | 2018 |
| Revs | $1,000,000 | $2,000,000 | $3,200,000 | $4,480,000 | $5,824,000 |
| Yr/Yr % | 100% | 60% | 40% | 30% |
So, let’s now look at profits, since valuations are ultimately a function of profits, not revenues.
Let’s say this fictional company is breakeven in 2014, but expects to make 10% EBITDA margins in 2015, growing to 25% EBITDA margins by 2018. So here are the EBITDA numbers that fall out of that.
(000s) | 2014 | 2015 | 2016 | 2017 | 2018 |
|---|---|---|---|---|---|
| EBITDA Margin | 0% | 10% | 15% | 20% | 25% |
| EBITDA | $0 | $200 | $480 | $896 | $1,456 |
Let’s say this fictional company’s stock will go up 10% a year each year until 2018. So the valuation goes from $20bn today to $29bn over five years.
(000s) | 2014 | 2015 | 2016 | 2017 | 2018 |
|---|---|---|---|---|---|
| Valuation | $20,000,000 | $22,000,000 | $24,200,000 | $26,620,000 | $29,282,000 |
| Yr/Yr Growth | 10% | 10% | 10% | 10% |
So here are the Revenue and EBITDA multiples that fall out of this thought exercise
2014 | 2015 | 2016 | 2017 | 2018 | |
|---|---|---|---|---|---|
| EBITDA Muiltple | 110.0 | 50.4 | 29.7 | 20.1 | |
| Revenue Multiple | 20.0 | 11.0 | 7.6 | 5.9 | 5.0 |
The point of all of these numbers is to show that if a company can grow very quickly over a five year period, and become highly profitable, the stock can perform well and the multiples can come down to earth pretty quickly.
That is a bunch of “ifs”, but every once in a while this actually happens. It happened with Google which now trades at 5-6x revenues, and it is happening with Facebook which is in the middle of this kind of a story. So my point is 20x revenues is a huge number, but every once in a while, a company actually deserves it.
For anyone who wants to dig into the numbers a bit more, here’s a link to the google sheet that I built as I wrote this post.
