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Tuesday, February 20, 2024

Moving The Narrative From ‘Loss Making’ To ‘Value Creation’ In Tech

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In the past 10 years, investor models have been flipped on their heads. As recently as 10 years ago, oil and gas and vehicle manufacturers dominated the world’s top 10 companies by revenues.

Now, six of the top 10 most valuable brands in the world are technology companies (Apple, Google, Microsoft, Amazon, Facebook and Samsung). Before reaching their current heights, many of these companies were loss making for years– and some of them still are. Understanding the true value of these businesses means stepping away from traditional methods of analyzing companies.

Telling An Accurate Tech Investment Story

Technology companies generate considerable value, which is often only recognized in the form of intangible assets, with market capitalizations that are based on high future earnings. An example of an intangible asset could be a software product a company develops, as it is something without a physical substance, yet is a crucial source of income and value generation for the company. All too often, the focus is on the “loss-making” element of a business’s results, without consideration to the “value” the business is creating.

When looking at financial statements of technology companies, the key numbers are revenue, revenue growth and cash. While profitability is not as important for growth companies, tech businesses need to show a clear path to profitability, so investors can understand the potential of a business. For SaaS companies, metrics such as subscription growth, average revenue per user, monthly recurring revenue, churn, customer lifetime value (LTV), and LTV to customer acquisition cost are the key numbers for public market technology investors to consider when analyzing the value of a business.

Well-known valuation methods such as the discounted cash flow (DCF) model allow you to assess the future income of a company. The DCF model is heavily reliant on cash flow data and typically works best for valuing companies with steady cash flows, such as utility businesses, which are very different in nature to technology companies.

The Value Of SaaS

SaaS stocks, in particular, are gathering momentum around the globe, and for good reason. As an investment opportunity, these businesses tend to offer large addressable markets, often globally. This shift reflects the changing behavior of consumers, who are moving from print to digital and from in-store to online.

Understanding the true value of these businesses means stepping away from traditional methods of analyzing companies.

In summary, to uncover the true potential of a publicly listed tech business, one needs to look beyond profitability and focus on long-term value. It is fair to say that yesterday’s methods for analyzing and valuing traditional business models are no longer as relevant in tech and SaaS.

An example of an intangible asset could be a software product a company develops, as it is something without a physical substance, yet is a crucial source of income and value generation for the company. While profitability is not as important for growth companies, tech businesses need to show a clear path to profitability, so investors can understand the potential of a business. For SaaS companies, metrics such as subscription growth, average revenue per user, monthly recurring revenue, churn, customer lifetime value (LTV), and LTV to customer acquisition cost are the key numbers for public market technology investors to consider when analyzing the value of a business.

The DCF model is heavily reliant on cash flow data and typically works best for valuing companies with steady cash flows, such as utility businesses, which are very different in nature to technology companies.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

Larger SaaS stocks on the Australian Securities Exchange (ASX), such as Nearmap and WiseTech, were first included in the ASX 300 (the top 300 ASX companies by market capitalization) in late 2016. I believe there is a structural shift toward “as a service” businesses in the public markets– the dominance of SaaS is a trend I expect to see continuing now and into the future.

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