DCF Help
How do you do a DCF for a company that has negative earnings? Wouldn't you just focus more on comps analysis & PT instead of DCF in this case?
Also as a follow up question, when would you not use a DCF?
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Yes, you are right— you would not use a DCF in this case because positive cash flows (the very things you are using to estimate value) are non-existent. I guess you could make a case for running a DCF on a pre-earnings company if you were extremely confident in positive earnings predictions in the years ahead... but that’s definitely a stretch and I’m not sure anyone would give it much weight. Much better to use comps and PTs.
You typically don’t use a DCF for pre-earnings companies (as discussed) or companies that have very volatile earnings that are hard to predict with any level of accuracy.
DCF: The issue isn't negative earnings so much as the FCF being unstable. Note that you may have negative earnings with positive cash flows but this still insufficient. Negative earnings implies that company isn't stable yet. Negative earnings aren't sustainable long-term so you know the company is either still in growth stage or distressed/on a downturn. Either way, the company's FCF will be unstable and you cannot use the perpetuity growth method to conclude a DCF valuation until the company has stabilized its growth.
You'd focus on comps multiples off of stabilized positive values - for TEV, is EBITDA positive? If not, use a sales multiple.
Earnings may be negative but what about FCF? You could try P/FCF. Lots of tech SaaS are earnings negative but FCF positive and you could slap on 20-30x multiple to get an equity valuation.
You can still do a DCF with negative earnings, this happens all the time for clinical-stage life sciences companies. You need to push out your time horizon.
Can you explain in more detail how you would do so? I am relatively new to the valuation methodologies?
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