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
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.
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.
So here are the Revenue and EBITDA multiples that fall out of this thought exercise
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.