Market-to-Revenue Multiples in Public and Private Capital Markets

Abstract

The behavior and determinants of market-to-revenue ratios in public and private capital markets is examined. Three samples are analysed: (1) all publicly traded stocks listed at some time on the New York Stock Exchange/American Stock Exchange/National Association of Securities Dealers Automated Quotation System in the 1980-2004 period; (2) sample of over 300 so-called ‘internet companies’ in the 1996-2004 period; and (3) over 5500 privately held venture capital-backed companies in the 1992-2004 period. Both company size and the most recent revenue growth rate are found to explain significant variation across companies in their market-to-revenue multiples – smaller companies and companies with higher recent revenue growth rates have higher multiples. We also document how the capital market appears to use a broad-based information set when setting market-to-revenue multiples for companies with negative revenue growth rates – transitory revenue growth components appear to be identified (in a probabilistic sense) by the capital market. Contrary to much anecdotal comment, we present evidence that the capital market behaved directionally along the lines predicted by capital market theory in the pricing of internet stocks in the 1996-2004 period.

Keywords: internet companies, market-to-revenue multiple, price/sales ratio, private companies, public companies, transitory revenue, venture capital