What do you do if your interviewer mistakenly "corrects" your answer?
The other day, I had an interview with a very small boutique. The interviewer asked me how I would value a new tech startup. I said that you can't use a DCF because it doesn't have stable cashflow so I would instead use Comps and Precedent Transactions and look at a multiple like EV/Revenue. He responded by saying you can't use Comps or Precedent Transactions because there are no good public comparisons for reference. Instead, he said he would make a DCF out to 15 years if necessary because it would be profitable at that point. Unless I'm missing something, isn't this answer blatantly wrong? At least, it's the complete opposite of what the M&I Guide says for valuing Facebook in 2004.
How would you respond in this scenario? Do you go along with his "correction" and let him think you're "wrong?" Or do you try to argue and explain why your answer is correct? I feel like if you argue, he's going to think you're a tool even if he realizes you're right. Thus, it seems like there's no way to win in this case.
A few comments:
1) Be ready and able to defend your assertions, if you try to exhibit that you are trying to learn why and you can back up your points, it’s not bad to push back, but if you are saying the M&I guide told me this vs. someone who was probably just working on this in “the real world” last week or that morning, please be humble and assume you are wrong
2. Yes in practice you probably can use some form of comp, they probably aren’t the only company with their margin and growth profile attacking a space, but ...
3) In practice 10/15 year DCFs are common. 10 year DCFs are essentially equity research standard today. Because the assumptions are so far out missing a number has huge ramifications on valuation and is part of the reason we see companies like Fastly post that they are going to miss assumptions and share prices crash. It’s hard but this is one of the things that establishes efficient markets. When there are limited companies to invest in and a lot of people wishing to park capital, traders will push prices to where expectations lead them and the best way to do that is through a long term DCF....
4) A question: If not an average of intrinsic estimates where do multiples come from?
TL;DR I love it when candidates get something wrong, I use it to test humility sometimes, and then proceed to try and learn from it. Very few do, but those who can show they can keep a stable head under pressure and make me want to hire them
Thank you for your response. What you're saying makes sense, but I feel like doing a 10- or 15-year DCF for an established company like Coca-Cola is an entirely different ball game than doing a 15-year DCF for Facebook in 2004. Once a company reaches a certain level of maturity, it becomes a lot easier to forecast accurately, no?
In regard to your question, what makes you say that multiples are an average of intrinsic estimates? Wouldn't you typically use the median current EV/EBITDA multiple of your comparable companies set? If so, current EV/EBITDA multiples aren't really estimates in the same sense that a pro forma set of financial statements are, right?
A few things, this is a very simple answer to a complex question and hopefully someone can expand and correct:
1. The nice thing about some early stage companies are that they generate recurring or reoccurring revenue so it’s almost like looking at annuity. Software is like this. Ads on a site like Facebook where you are going to keep coming back are as well. It comes down to probability - what’s the probability of it actually happening. This is one of the ways that prices are driven up.
2. Do multiples just appear out of thin air? If it never goes back to the aggregates of some intrinsic analysis then it implies that multiples just must be a guess...
3. There is a lot of probability involved in pricing and valuation, the future is unknown so we use the best methods we can to try and make a hypothesis
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