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I notice that a lot of valuation guidance, such as some online calculators, make company valuation a function of earnings. Therefore a company with small earnings (or no earnings) is valued at 0. For example, a company with $50 million in sales, but $1 million in earnings every year, might be valued at only $5 million, for example, which does not seem logical to me, especially for a growing company. Nobody would sell a growing company with $50 million in sales for $5 million.

What is the story here? Is there a another valuation method that is more reasonable? Does anybody actually use the bogus earnings-based valuation or is that just a pro forma method with no real practical application?

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    A company is only worth as much as someone else is willing to pay for it. Without knowing who that someone else is, and what they are thinking, then I'd go with the latter of your options. – TTT Jul 15 '16 at 21:30
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    Valuations in general are biased and based on many assumptions. – Victor Jul 15 '16 at 22:22
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The valuation method depends on what the company does and its upside potential.

For example, The figures you quote, $50M sales, $1M EBITDA, $5M price would be a standard transaction for, say, the sale of a Honda dealership in a small to mid-sized town.

On the other hand, Google purchased Youtube for $1.67B before it made a dollar of revenue. And Amazon had a market cap of several billion before it made its first dollar. So valuation is highly dependent upon the nature of the subject company involved.

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You aren't going to like this answer, but frankly if sales don't increase net earnings, then they don't add value.

Imagine 2 companies in the same market:

Company A has $100M in sales, and $10M in net earnings.

Company B has $50M in sales, and $10M in net earnings.

Which company barring all other information seems more stable, to you? Or more profitable? Assume a new market goes up, with total possible sales of this product of $50M. If the two companies continue earning net income in a similar proportion to sales (which may or may not be a good assumption, but it is partially one of the core assumptions used in earnings-based growth projections), then Company A will earn $1 for every new $10 in sales, whereas company B will earn $1 for every $5 in new sales.

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Enterprise valuation is really more of an art than a science. The general idea is you're buying the future profitability of the company. "How much would you pay for a machine that prints $1,000,000 per year?" The answer is probably significantly more than $1,000,000. How much would you pay for the same machine but isn't actually done yet and might not ever work?

No one factor can be reliably used to value a company. There is no single multiple that can be applied to top line sales to result in a valuation that would be reliable at all.

Additionally you'd have to consider any number of external issues like if there was a big pending lawsuit or there was legislation floating around seeking to restrict sales of the company's product or any number of other possible potentially detrimental scenarios.

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  • I am talking about a company that has no "problems" like a large debt load. Obviously, you can downgrade a company by having it located in Zimbabwe, having $1 billion in debt, under indictment by the UN, and the headquarters is in flames. I am talking about a normal US tech company with no problems. – Five Bagger Jul 15 '16 at 21:21
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    @TylerDurden "Tech company with no problems" well with a tech company, are you sure the tech is actually going to deliver what they promise? It is very naive to assume that a company not literally on fire is A-OK. – Grade 'Eh' Bacon Jul 15 '16 at 21:32
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    You mean like when AOL bought Time Warner? How about when Netscape and Yahoo! were big Internet names? There are more than a few tech companies that have gone away or at least have had their stock take a massive hit over the years. – JB King Jul 16 '16 at 0:38

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