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How to Value a Company With No Profits?

The price to earnings ratio (P/E) has always been a favourite valuation tool among investors. For one, it is easy to understand, and the data is freely available.

However, there will come a time, when you hear about a company that has so much potential that it has plans to take over the world. Yet when you open up their annual report for the past few years, they have never been profitable. What are some of the techniques that might be useful for you to value this company at this point?

Alternative valuation techniques

One commonly used method is the discounted cash flow (DCF) model, where we can project the future free cash flow of the company after taking into account changes in its working capital and capital expenditures for the next few years.

As the output of this method is very sensitive to our input-assumptions, we have to make sure we are not overly optimistic in our assumptions when we carry out valuation work.

We may also consider using the Enterprise Value-to-EBITDA model (EV/EBITDA), in cases where the company is at least having positive earnings before interests, tax, depreciation and amortisation (EBITDA). Meanwhile, the EV of a company is given in the equation below:

Enterprise Value = Market Capitalisation + Total Debt + Minority Interests – Total Cash

When we divide EV by EBITDA, we can then use the ratio to compare between different companies and find the ones which are more undervalued. Generally speaking, investors tend to prefer companies with a low EV/EBITDA, all else being equal.

If those fail too, we can always compare companies using the price to book ratio (P/B). However, it is important to know that the value of some companies (like tech companies for instance) are not reflected in their balance sheets and the P/B ratio might be completely irrelevant for them.

On the other hand, the P/B ratio can be a good indicator of value for companies with large current liquid assets, like banks.

Foolish Bottom Line

I’m pretty sure that if our investment strategy consists of us investing only in unprofitable companies, our performance would likely suffer. At the same time, however, not all unprofitable companies are bad investments; one such unprofitable company that turned out well has been casino and resort owner Genting Singapore (SGX: G13).

It had been making losses for the whole period when Resorts World Singapore was still under construction. But, profits started kicking in after the tourist attraction begun openings its doors.

Genting Singapore’s position as one of the 30 constituents in the Straits Times Index (SGX: ^STI) is now much stronger ever since and the chart below showcases how much its share price has grown over the years.

Genting Singapore Chart

Source: Yahoo Finance

All told, this goes to show how there is never a fixed formula for investing.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.