Valuation Series 2: It's the Story That Matters!
There has been a lot of talk about “unheard of” valuations for new age firms such as aggregator services – Uber and AirB&B. There also, has been talk of valuations for firms that have barely ever posted profits – such as Tesla and Amazon. What makes the market buy these even though their books don’t show impressive results. Would you invest in a company that has net margins of less than 1% and has never paid a dividend? Most probably your answer will be no, but then why does Amazon have the valuation it does when their net margins are negligible and they have barely posted profits? This is where it gets interesting. What are investors buying into? It is the narrative behind Jeff’s actions that makes Amazon a very compelling story. They have chosen to fuel growth against all odds, even at the risk of disappointing shareholders. But are the shareholders disappointed? The chart below will tell you they definitely are – NOT:
It reminds me of Aswath Damodaran’s blog from earlier this year (also referred to in his book - Narrative and Numbers: The Value of Stories in Business, 2017), “I think of valuation as a bridge between stories and numbers, where every story becomes a number in the valuation and every number in a valuation has a story behind it.”
Aswath outlines the following steps for bridging value with numbers:
Develop a narrative for the business being valued – this is your story about the business’ potential and growth.
Test to make sure, the story is possible then plausible and finally probable – There are lots of possibilities but only a few are probably going to happen. It is important to assign probabilistic weights to different outcomes.
Convert the story into value drivers – connect all parts of the story to numbers and all numbers that you so arrive at should be supported by your story.
Connect the numbers to a valuation – make the numbers into simple realistic assumptions and use them to arrive at a final value.
Speak to your network and those around the business, keep the interaction continuous – stories evolve based on new information. Always have “go-to” guys that are closed to the industry, the business model to help refine your story.
At Falak the team has, for years, been following the below process for conducting valuations.
I think in our own innovative way, we managed to bring the story tellers (dreamers as we refer to them internally) and the number crunchers (suits as they are lovingly called) together and now they have all evolved into a good mix of pragmatic and intelligent valuation consultants.
In conclusion, I would like to say that it is important to demystify the world of complex models based on assumptions that are highly improbable and follow what the potential can be while thinking of businesses. It is all in the stories that we don’t usually bother to see.
This blog is written by Jitender Shekhawat from Falak Consultancy WLL (“Falak”), a company registered in Kingdom of Bahrain and is only for general information purpose though unsolicited circulation. This write up does not constitute any offer, recommendation or solicitation to any person to enter into any transaction or subscribe to any services. It does not serve as or replace or amend the terms or nature of any products or services offered by the company. The reader of this material alone shall be fully responsible/liable for any decision taken based on this material. All readers are advised to make their own investigation, their own independent judgment with respect to any matter contained herein. Falak will in no manner be responsible for an individual’s decision made based on the recommendation/views estimations made in this document.