The Dark Side of Valuation: Firms with No Earnings, No History and No Comparables
54 Pages Posted: 7 Nov 2008
Date Written: 1999
In traditional valuation models, we begin by forecasting earnings and cash flows anddiscount these cash flows back at an appropriate discount rate to arrive at the value of a firm or asset. This task is simpler when valuing firms with positive earnings, a long history of performance and a large number of comparable firms. In this paper, we look at valuation when one or more of these conditions does not hold. We begin by looking ways of dealing with firms with negative earnings, and note that the process will vary depending upon the reasons for the losses. In the second part of the paper, we look at how to value young firms, often a year or two from start-up, with negative earnings, small ornegligible revenues and few comparables. We will argue that while estimation of cashflows and discount rates is more difficult for these firms, the fundamentals of valuation continue to apply. Finally, we look at how best to do relative valuation for young firms with negative earnings and few comparables.
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