Should Revenue Multiple Be The Metric To Value New-Age Companies?
Revenue multiples serve as a good proxy but should be used judiciously, says JM Financial.
The market’s use of revenue multiple to compare valuations across new-age companies can be a “decent proxy” to traditional metrics but should be used “judiciously”, according to JM Financial.
“With majority of new-age stocks still incurring losses, traditional valuation comparisons such as earnings and Ebitda multiple aren’t possible and sales multiple has become the preferred multiple for investors wanting to compare valuations across these companies,” the research house said in a June 24 report.
While that could serve as a good proxy, it should be used judiciously as quality of revenue needs to be understood in order to compare multiples across new-age stocks that operate in different industry verticals and have significantly different revenue recognition approaches, it said.
Over the past year, several new-age companies such as CarTrade Tech Ltd., FSN E-Commerce Ventures Ltd. (Nykaa), One97 Communications Ltd. (Paytm) and Zomato Ltd. have debuted on the bourses. While the stocks have taken a beating amid a global tech selloff and an otherwise subdued sentiment, Paytm founder Vijay Shekhar Sharma has defended tech firms, saying the markets will take time to understand their business models.
JM Financial suggests “due consideration to be given to revenue chararcteristics—competitive moats, network effects, gross margin profile, growth rate, capex/working capital requirements and recurring nature of business”.
“Whereas these revenue characteristics will help understand why certain companies should trade at higher multiples compared to others, gross profit multiples can be used for comparing the new-age companies as it is a simple way to remove the impact of differing revenue recognition approaches,” it said.
Gross margin, according to JM Financial, is the simplest indicator of quality of revenue. “Evaluating companies on gross margin also takes away the impact of gross merchandise value/revenue growth coming at the cost of poor commissions/buy-sell margins. While Nykaa trades at a 60% premium compared to Zomato on revenue multiple basis, the variance is much steeper on gross profit multiple basis at 200%+.”
Also, marginal incremental profitability should be actively tracked to understand the bottom line impact of revenue growth. “Companies that can grow predictably in a sustainable fashion with strong marginal incremental profitability are the ones that should always be trading at premium revenue multiples.”