Valuing Unprofitable Companies: Sales, Margins and Time

The income statement ends in a loss, again. Revenue grew fast. Operating expenses grew nearly as fast. The P/E column on the screener is blank, because there are no earnings to divide by, and the discounted cash flow model from earlier in the course has nothing positive to start from. Price to sales is the only multiple left. As the multiples lesson showed, it ignores margins entirely. So skip the unprofitable years. Jump to the one where the business looks grown-up, estimate what it earns there, and bring that figure back to today.

Forecast to a mature year

Choose a year when growth should have slowed to something ordinary and margins should look like those of established companies in the same industry. Five years out is a reasonable start. Take a hypothetical company with $100,000,000 of revenue today. You forecast $500,000,000 in year five.

That forecast carries a big claim. Revenue has to multiply by five. Compounded, that’s roughly 38% a year for five years straight, since 1.38 to the fifth power is about 5.0. Ask yourself how many businesses you know that kept up that pace. Then decide whether this one has a reason to.

Apply a mature margin and a multiple

Next, the margin. Look at profitable companies selling similar products and read their net margins from the annual reports. Suppose they cluster near 15%. Apply that to year-five revenue and you have year-five earnings. Put a multiple on those earnings that fits a company growing at a normal rate by then, which usually means something near what mature peers trade at today, since by year five the business ought to look like one of them.

Then discount the whole value back to today. Use a high required return, because every step so far has been a forecast. The example uses 12%.

Each input matters. A 10% margin in place of 15% cuts earnings by a third, and the value today falls by the same third.

Count the shares that don’t exist yet

A company that loses money pays for those losses somehow. Usually it sells shares. It may issue stock in a follow-on offering, pay staff in stock grants, or borrow through convertible notes and warrants that turn into shares later, and every one of those routes leaves the eventual profits split more ways.

Divide by the count you expect in year five. Suppose the company has 100,000,000 shares now and you expect 120,000,000 by then.

That’s a 17% cut to the per-share value from issuance alone. The share count history walkthrough shows where to find the past rate of issuance, which is usually the best starting guess for the future one. The viewpoint that stock warrants are dilution on a delay covers the shares hiding in the notes to the accounts, and the share dilution calculator runs the arithmetic for any count.

Weight success against failure

The model above assumes the plan works. Many don’t. A simple fix is to value a failure case too and weight the two. Say you give the plan even odds, and a failed company, sold for its technology and customers, would fetch $100,000,000.

From $8.51 to $3.96. Nothing about the company changed, only the honesty of the inputs, and the gap is where a margin of safety from the previous lesson earns its keep.

Where it stops holding

The method can’t tell you whether a mature margin will ever arrive. Some industries never reach one, and a company that keeps reinvesting may show losses for longer than the model allows. Run it at several years, margins and share counts. Treat the spread as the answer. Set that range beside the price and ask whether the market is charging you for the success case alone. The reverse DCF from the margin of safety lesson answers it: hold the price fixed and solve for the year-five revenue it implies.