The Missing Insight Around Software Multiples for Valuing Companies

If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here.

The Missing Insight Around Software Multiples for Valuing Companies

Jan 10, 2021 04:00 pm

Imagine two public SaaS companies, identical in every respect but one. The first grows revenue twice as fast as the second. How much more valuable should the first be? Twice as valuable isn’t the answer.

Most investors value stocks using multiples, which tend to obscure the underlying drivers of value. Many investors also seek to distinguish between value and growth stocks, which are commonly sorted based on multiples of earnings or book value. The important drivers of value are opaque with these practices, and very few investors have a clear sense of how revisions in expectations for those drivers change multiples.

image

Michael Mauboussin is a leading markets thinker. He wrote a short paper recently called The Math of Value and Growth that’s worth sharing to answer the question in the first paragraph. He included this chart which shows the P/E multiple on the y-axis and NOPAT (Net Operating Profit After Tax), a measure of profitability on the x-axis.

The key point is that a company growing faster should enjoy a multiple that grows geometrically with the growth rate, not linearly.

Let’s plot the current multiples of software companies to see if the shape appears in the current market. The vertical axis differs because most software companies are typically valued on forward multiple, not Price/Earnings (P/E).

image

The answer is yes. There is a geometric curve to forward multiples, so the market does recognize the compounding power of growth rate, as Mauboussin’s model says it should. It’s not a perfect curve as there’s a dip in the 50-60% growth rate.

That dip may be because I haven’t isolated other variables like profitability, market size, gross margin, and many others.

What we haven’t solved, and will never solve though, is the right scale of the y-axis. Is the span of 3 to 80 NTM forward multiples the “right” one that accurately values companies today based on market conditions? I’m afraid no model can answer that fully.

But the point we can make today is that multiples should follow a power-law, a geometric shape as a function of growth rate, and they do in the public software markets. And that’s why growth is so desirable: it increases the value of the company exponentially.


Read in browser »
share on Twitter Like The Missing Insight Around Software Multiples for Valuing Companies on Facebook


 

Recent Articles:

Information Cascades - How Many Rational People Can Make Logical Decisions and Yet Still Create a Bubble
The Next Chapter for StackRox
Why Remote Work Changes the Nature of Leadership, and the Kinds of Leaders to Recruit in Startups
Why Fast Learning Curves are So Important to Startups
5 Predictions for 2021
Copyright © 2021 *|Tomasz Tunguz|*, All rights reserved.
You signed up to receive Ex Post Facto blog posts by submitting your email on tomtunguz.com

Our mailing address is:
Redpoint Ventures
3000 Sand Hill Rd
Menlo Park, CA 94025

Add us to your address book


Want to change how you receive these emails?
You can update your preferences or unsubscribe from this list.
 

Older messages

Information Cascades - How Many Rational People Can Make Logical Decisions and Yet Still Create a Bubble

Friday, January 8, 2021

If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here. Information Cascades - How Many Rational People Can Make Logical Decisions and Yet Still Create a

The Next Chapter for StackRox

Thursday, January 7, 2021

If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here. The Next Chapter for StackRox Jan 06, 2021 04:00 pm Today, RedHat announced that it has acquired

Why Remote Work Changes the Nature of Leadership, and the Kinds of Leaders to Recruit in Startups

Monday, January 4, 2021

If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here. Why Remote Work Changes the Nature of Leadership, and the Kinds of Leaders to Recruit in Startups

5 Predictions for 2021

Friday, December 18, 2020

If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here. 5 Predictions for 2021 Dec 16, 2020 04:00 pm Every year, I make a list of predictions and score

The Three Questions to Ask When Hiring Your Startup's Head of Sales

Wednesday, December 16, 2020

If you were forwarded this newsletter, and you'd like to receive it in the future, subscribe here. The Three Questions to Ask When Hiring Your Startup's Head of Sales Dec 14, 2020 04:00 pm Mark

You Might Also Like

#207 | Agentic Commerce, Energy Theses, State of Gen AI, & more

Sunday, November 24, 2024

Nov 24th | The latest from Scale, USV, Madrona, Menlo Ventures, Redpoint, and others ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏

$12K/mo AI App for grandmas

Sunday, November 24, 2024

Starter Story Sunday Breakfast ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏

🎓 Learn from these legends to supercharge your 2025

Sunday, November 24, 2024

And save 40% while doing so with our greatest Black Friday deal ever! Black Friday_Header_2 Hey Friend , This Black Friday, you get the biggest, most lucrative sale we've ever offered—and with it,

The ultimate guide to founder-led sales | Jen Abel (co-founder of JJELLYFISH)

Sunday, November 24, 2024

Learn how to master founder-led sales with Jen Abel of JJELLYFISH: tips on outreach, leads, closing deals, and hitting your first $1M ARR ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏

🗞 What's New: ~40% of young adults get their news from influencers

Saturday, November 23, 2024

Also: "File over App" for digital longevity ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏

Initiator Creator - Issue 145

Saturday, November 23, 2024

Initiator Creator - Issue #145 - ( Read in browser ) ​By Saurabh Y. // 23 Nov 2024 Presented by NorthPoll​ This Week's Notes:​ ​Content-rich designs looks more convincing I just love how Basecamp

🛑 STOP EVERYTHING 🛑 BLACK FRIDAY IS NOW!

Saturday, November 23, 2024

This is your sign to take action—2025 could be your breakthrough year, but only if you start now. Black Friday_Header_2 Hey Friend , This is getting serious. We're handing over $1700 in value as

What’s 🔥 in Enterprise IT/VC #421

Saturday, November 23, 2024

Thoughts from Goldman's PICC + optimism for 2025? ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏ ͏

I'm blue

Saturday, November 23, 2024

Hey, ​ ​ tl;dr – I've decided to delete all my Twitter posts, lock down my account, and leave the platform. And I'm going all-in on Bluesky, which (in the last month) has become 1000x more fun

🚀 Globalstar to the Nasdaq

Saturday, November 23, 2024

Plus $RKLB CEO becomes a billionaire, DIRECTV $SATS debt deal called off, TEC's $160M Series B, and more! The latest space investing news and updates. View this email in your browser The Space