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Ask HN: How does annual profit relate to company valuation?
I have been asked by a relative to help evaluate a potential acquisition. Let's say the company makes $1 million a year in profits, with less than $50,000 in annual expenses. Assuming revenues and expenses remain the same for the foreseeable future, how do we determine if the selling price is reasonable?
- greenyoda 12y agoIf the revenues and expenses are static, you're looking at a revenue stream of $950,000 per year. To evaluate whether you're getting a good price, you have to consider what alternative investments you can put that money into, and what the relative risks of these investments are. For example, let's say the asking price for the company was $50 million. For that money, I could buy $50 million worth of 10 year US Treasury bonds that would give me a risk-free return of $935,000 per year at the current yield of 1.87% [1] (without having to run a company). So hopefully you're paying much less than $50 million for this business, since it's much more risky than Treasury bonds. It's probably also a lot more risky than investment-grade corporate bonds yielding 3.47%.[2] What are some of the potential risks? A competitor could take away a significant chunk of your market share, one or more key employees could quit, your expenses could rise, the economy could tank, etc. If your relative is planning on spending millions of dollars on an investment, they should probably get financial advice from an expert who knows what they're doing, not from random people on the internet. [1] http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/ http://www.bloomberg.com/markets/rates-bonds/government-bond... [2] http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/ http://www.bloomberg.com/markets/rates-bonds/corporate-bonds...
- MichaelCrawford 12y agoAlso consider taxes. What taxes would your relative pay on this acquisition, as opposed to the taxes they would pay by doing something else. Do they intend to acquire it and hold it for a long time? If so long-term capital gains is helpful.
- codeonfire 12y agoWhat is the free cash flow, 950k a year? The value is all discounted future free cash flows. Or the value is just whatever the buyer is willing to pay. Obviously lots of acquisitions will never pay for themselves because they are strategic acquisitions. Will minecraft ever make $2.5 billion? I would take future discounted cash flows, multiply by 3 for the hassle and call it good.
- brudgers 12y agoSound analyses don't assume revenue and expenses remain constant. They assign a probability to that happening and discount discounted future cash flows accordingly. Sound analyses also look at the liquidity of the asset, market trends and potential market changes, and trends and changes in the underlying industry. They also scrutinize the books via an accountant and the underlying infrastructure. It's also worth figuring out why the Owner is selling the business in the current market. But in the end, assuming your relative is a reasonable buyer, then the selling price is reasonable if your relative buys. Good luck.