Latepost Next Upward On Groupon
In my final post, I made an endeavor to value Groupon in addition to came upwards amongst $14.62/share, before the voting right adjustment. Now that the offering is consummate in addition to the get-go hateful solar daytime of trading is over, I thought it would endure useful to accept stock of full general lessons that tin endure drawn from this deal. The offering toll was raised to $20/share in addition to tarticle/SB10001424052970203716204577017773545604142.html?mod=WSJ_hp_LEFTTopStories">he stock jumped some other 40% during the course of report of the day. So, hither are a few questions that I am fielding today...
1. Is it possible that y'all are incorrect inward your assumptions in addition to that other investors are far to a greater extent than optimistic virtually revenue growth/ operating margins?
There is no room for hubris inward markets. Investors who practise non acknowledge to their mistakes, gear upwards them in addition to motion on are doomed to pay a steep price. So, I volition start amongst the presumption that I am incorrect in addition to the marketplace position is right in addition to assess the likelihood, using ii techniques.
- Implied growth/margins: The ii cardinal inputs inward this valuation are revenue growth in addition to the target operating margin. In the tabular array below, I changed both those numbers in addition to assessed the behave on on value per share. I equally good highlighted the combination of growth/margin assumptions that would larn me to $28/share. For instance, if Groupon tin keep a revenue growth charge per unit of measurement of 70% a twelvemonth for the adjacent 5 years (which volition laissez passer on them revenues of $64 billion inward 10 years) in addition to a target operating margin of 23% a year, the value per portion is $39.81. Notice that at that topographic point is no scenario where the revenue growth is less than 60% a twelvemonth for the adjacent 5 that delivers a value greater than $28/share. (There are a few strange quirks inward the table, where the value decreases equally the margin increases, for a given revenue growth rate. That is because the NOLs that y'all accumulate fall over into the terminal value. Suffice to say that if your excogitation amongst Groupon is for them to lose so much coin that they volition never run out of NOLs, y'all should mean value again...)
(Revenues inward twelvemonth 10 inward brackets adjacent to 5 twelvemonth growth rate)
- Simulations: In the final few years, I have got used an improver to Excel called Crystal Ball to run simulations. In a simulation, y'all input distributions for cardinal inputs where y'all experience uncertain virtually the future. In the Groupon valuation, I made revenue growth in addition to operating margin into distributions – compounded 5-year revenue growth is uniformly distributed betwixt 30% (pessimistic end) in addition to 70% (optimistic limit) in addition to the target operating margin is assumed to endure normally distributed, amongst an average of 23% in addition to a touchstone departure of 4%. I so ran 10,000 simulations, drawing from the distributions, in addition to presents a distribution of values, shown below. Note that at that topographic point is entirely a 15% direct chances that the value is greater than $28 (1500 outcomes out of the 10000 yielded values of $28 or higher). In fact, spell the average value is around $14, at that topographic point are far to a greater extent than outcomes nether $10 than above... Put differently, y'all are non going to win on this stock most of the time, but if y'all do, y'all have got to promise it is a big win.
2. Is it a occupation amongst the approach? Does DCF systematically undervalue young, growth companies?
As many of y'all know, I am a staunch defender of discounted cash menses valuation, but hither are a twain of criticisms I have got heard of the model (especially inward the context of valuing young, growth companies similar Groupon) that I desire to address.
As many of y'all know, I am a staunch defender of discounted cash menses valuation, but hither are a twain of criticisms I have got heard of the model (especially inward the context of valuing young, growth companies similar Groupon) that I desire to address.
a. DCF valuation is inherently conservative. It volition nether value growth companies.
An analyst that I was chatting amongst inward the final hateful solar daytime was dismissive when I gave him the outcome of my Groupon valuation, in addition to his claim was that “DCF valuations ever understate the value of young, growth companies”. But is that true? Those of y'all who have got been reading my blog in addition to know that I valued Facebook, Skype in addition to Linkedin before this summertime (and flora them all over valued) may really good conclude that I would discovery all social media companies to endure over valued right now. That may endure true, but it cannot endure generalized to DCF equally a technique. There is a bias that comes from the timing of these valuations: I chose these companies to value because they were inward the tidings in addition to were either going world or thinking virtually it. But when practise companies inward a sector mean value virtually going world or offering themselves for sale? It is when managers believe they volition have a favorable valuation. Put differently, I am valuing social media companies at a fourth dimension when the marketplace position is most probable to endure over valuing them. To supply some perspective, I valued dozens of point com companies inward the 1998, 1999 in addition to 2000 in addition to I flora every i of them to endure over valued. In 2001 in addition to 2002, when I revisited the sector (or what was left of it), I flora many of the same companies to endure nether valued. In the graph below, for instance, I have got my value in addition to the marketplace position toll for Amazon.com each twelvemonth from 2000 to 2003; notice how over valued it was inward early on 2000 in addition to how nether valued it looks inward 2001. The bottom line: DCF is non inherently conservative, but done right, it is contrarian. You are probable to discovery stocks to endure nether valued when the marketplace position mood for a sector is darkest in addition to stocks over valued when investors are enamored virtually a sector.
b. DCF valuation misses components of value
- There is some truth inward this declaration in addition to I did embrace i aspect when I talked virtually the “option” premium inward some growth companies inward my before post service on the value of growth. What am I talking about? If I had valued Apple equally a personal figurer companionship inward 2000, I would have got missed its expansion into the amusement occupation organisation inward the final decade. Similarly, if I had priced Google equally a search engine inward 2004, I would non have got considered its expansion into other businesses inward the final few years. If Groupon is successful inward its pith business, could it expand into other businesses? Sure, but at that topographic point are ii levels at which I would endure skeptical inward this case. First, I am non certainly what Groupon competitive border volition endure inward these unspecified novel businesses. Second, fifty-fifty when I have got estimated a existent selection premium, I have got never obtained an increment of to a greater extent than than 20-25% on my DCF value.
- The other declaration is that Groupon is issuing entirely 5% of its shares inward the IPO in addition to that the shares are thence scarce: investors who desire the stock thence have got to pay a scarcity premium. But shares inward a companionship is non a Tiffany light or a Mickey Mantle baseball game card. It is a claim on a laid of cash flows in addition to who generates these cash flows or how they are generated is non relevant. (As far equally I tin tell, a dollar y'all generate inward cash flows from your Groupon investment buys just the same amount equally a dollar inward cash flows y'all generate from your Apple or Google investment.)
3. If y'all believe that the value is entirely $14 or $15 a portion (or lower), how practise y'all explicate the $28/share price?
My get-go reply is that I experience no urge to explicate the $28/share price, since I did non pay it. My 2nd is that this is a snarky reply in addition to that I should endure able to set myself inward the shoes of those who did purchase the stock today in addition to explicate why. I could accept the generous thought in addition to attribute their actions to more optimistic assumptions virtually growth/profitability (and a higher value). I mean value that at that topographic point is a simpler, to a greater extent than probable explanation. I would wager than most of the investors buying Groupon stock today have got absolutely no thought what its value is in addition to could non tending less. They are playing a really unlike game than I am. With a fourth dimension horizon measured inward minutes, hours in addition to days, they are buying the stock today, hoping to flip it to someone else at a higher toll adjacent week. Will some of them make money? Sure, in addition to I don't begrudge them their profits. It is simply a game I am skillful at in addition to I won't fifty-fifty try!
My get-go reply is that I experience no urge to explicate the $28/share price, since I did non pay it. My 2nd is that this is a snarky reply in addition to that I should endure able to set myself inward the shoes of those who did purchase the stock today in addition to explicate why. I could accept the generous thought in addition to attribute their actions to more optimistic assumptions virtually growth/profitability (and a higher value). I mean value that at that topographic point is a simpler, to a greater extent than probable explanation. I would wager than most of the investors buying Groupon stock today have got absolutely no thought what its value is in addition to could non tending less. They are playing a really unlike game than I am. With a fourth dimension horizon measured inward minutes, hours in addition to days, they are buying the stock today, hoping to flip it to someone else at a higher toll adjacent week. Will some of them make money? Sure, in addition to I don't begrudge them their profits. It is simply a game I am skillful at in addition to I won't fifty-fifty try!
4. If y'all believe that the intrinsic value is entirely $10-$15, should y'all brusque the stock?
In the Google shared spreadsheet that I set upwards inward my final post, I notice that many of you, who flora the stock to endure over valued, excogitation to sell brusque the stock. You are far braver than I am! I did non sell brusque on whatsoever of the point com companies that I flora over valued inward 1999 in addition to early on 2000. In hindsight, could I have got made coin yesteryear doing so? Eventually, yes, but eventually would have got been a long fourth dimension coming on some of those stocks... My occupation amongst selling brusque has ever been that I don’t command my fourth dimension horizon; the somebody who has lent me the shares does. After all, fifty-fifty if y'all are right inward your assessments of value, y'all volition non make money until the marketplace position corrects its “mistakes” in addition to that may accept weeks, months or fifty-fifty years. With hot sectors, where prices are based on perceptions in addition to the herd is “optimistic”, I mean value it is far to a greater extent than prudent to leave of absence of the agency in addition to permit the momentum investors have got their hateful solar daytime inward the sun. My hateful solar daytime volition come!!!!
In the Google shared spreadsheet that I set upwards inward my final post, I notice that many of you, who flora the stock to endure over valued, excogitation to sell brusque the stock. You are far braver than I am! I did non sell brusque on whatsoever of the point com companies that I flora over valued inward 1999 in addition to early on 2000. In hindsight, could I have got made coin yesteryear doing so? Eventually, yes, but eventually would have got been a long fourth dimension coming on some of those stocks... My occupation amongst selling brusque has ever been that I don’t command my fourth dimension horizon; the somebody who has lent me the shares does. After all, fifty-fifty if y'all are right inward your assessments of value, y'all volition non make money until the marketplace position corrects its “mistakes” in addition to that may accept weeks, months or fifty-fifty years. With hot sectors, where prices are based on perceptions in addition to the herd is “optimistic”, I mean value it is far to a greater extent than prudent to leave of absence of the agency in addition to permit the momentum investors have got their hateful solar daytime inward the sun. My hateful solar daytime volition come!!!!
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