Viewing Valuation as a Discount of Future Value


This post is by Tomasz Tunguz from Tomasz Tunguz


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Why does growth rate matter so much? Why does growth rate influence valuation so much? I was reading a book recently written by a hedge fund manager who discussed valuation frameworks. His explanation was one of the best I’ve come across. If your business is growing at 100% next year, then 90% the year after, and then about 80% the year after, the business will have grown by 3.4x. That’s the way I’ve always looked at company. But this hedge fund investor said it a different way: 85% of the value of the business will be created in the next 3 years. At 10% growth, the company’s value today is 77% of the value in three years. The value won’t change that much. It’s already the most of the size it will be. Same cup, same water, just a different perspective. The chart above shows how this changes with growth rates. It assumes a company starts growing at the growth rate on the y-axis. This growth rate falls 10% each year. On the x-axis, you can see the fraction of the enterprise value (EV) that will be created in the next 3 years. Instead of looking at today’s valuations as a multiple of current revenues, we can think about it as a discount to the future value. This math makes that perspective concrete. Photo by Daniel Mayovskiy on Unsplash

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