DCF using Revenue Multiple?
Hi, so I know that there are many multiples you can use in the exit multiple method in a DCF, but I was wondering if using a revenue multiple is okay, or if you need to stick primarily to EV/EBITDA
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its ok
You can use any multiple you want that gets you to TEV (for unlevered DCF). But EBITDA is typically used because it’s somewhat of a stretch to assume a business (especially one that’s cash flow positive and is conducive to a DCF) will trade on revenue 5-7 years from now.
You can use whatever you want in a DCF since it's more art than science, but a revenue multiple is just harder to defend than an EBITDA multiple. The reason why companies get valued off revenue growth is usually because they're high growth and they're being valued off future potential more than their current profitability. The terminal value in a DCF is meant to capture the discounted future value of the company beyond the projection period. So to use a revenue multiple is sort of suggesting this company will grow at an above normal pace forever. To me it's similar logic as to why you wouldn't have the long-term growth rate be > GDP rate.
Mathematically, yes, you can use a Revenue multiple and get your implied EV and Stock Price (if desired). In practice, however, this generally isn’t preferred. If you think about the last year of your explicit forecast horizon in a DCF, it should be or is about to be at a “steady state”. The year right before the terminal period, which Revenue and EBITDA multiples would be calculated off of, should be an extremely close reflection reflection of what the company will be growing at perpetually. This is the same reason that if you are projecting a terminal growth rate of 3%, the year’s Revenue growth right before the terminal period can’t be like 15% and then drop off a table to 3%. Using a revenue multiple implies that a company is not yet at a mature state because of lack of material operating profitability, which is very hard to justify if your going to jump into infinity the next year. If you cannot realistically use and EBITDA multiple yet, I would recommend that you extend out the forecast horizon to maybe 10 years so that you can smoothly reach the margin profile you need. It’s pretty reasonable to say that a company, in the practice of doing valuation, can reach a mature state (again, stretching for just valuation purposes) within 10 years.
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