Why do tech companies trade at higher multiples?
Tech stocks have relatively high valuation multiples because that's what has been assigned, usually at IPO, and now the Street must come up with explanations, similar to how medieval astronomers had to make sure their models showed the earth at the center of the universe.
- Communications: 11 – 12 times EBITDA.
- Consumer Discretionary: 13 – 18 times EBITDA.
- Consumer Staples: 13 – 15 times EBITDA.
- Energy: 7 – 15 times EBITDA.
- Health Care: 14 – 15 times EBITDA.
- Industrials: 11 – 14 times EBITDA.
- Info Technology: 11 – 18 times EBITDA.
g: the higher the growth of a business, the higher the multiple. t: the higher the taxes on a business, the lower the multiple. ROIC: As long as ROIC is greater than the opportunity cost of capital (r), the higher the ROIC of a business, the higher the multiple.
The two most popular valuation multiples for software companies are Price to Sales (P/S) and EV/EBITDA. Many software companies operate at a loss until they scale to a large enterprise. For that reason, you see negative net income and a lot of the times, negative EBITDA.
As of 2021 81% of the revenues come from the advertising networks of Google. In fact, advertising generates over $209 billion dollars in revenues; no doubt that is the cash cow for Google. What is this? It is also true that the company is growing other revenue streams (such as Apps, Google Cloud, and Hardware).
Recurring revenue and fast growth
Their fast growth coupled with recurring revenue is a major reason why their valuations are higher.
Tech valuations have endured stark declines this year. But after continued selling, it's now possible to argue that the selling has gone too far — that tech valuations are now suffering more than is warranted in the wake of the 2020-2021 tech stock bubble.
Latest Twelve Months | 8.8% | 42.1% |
Current Trading Multiples | ||
EV / LTM Revenue | 0.63x | 10.85x |
EV / LTM EBIT | 7.2x | 25.8x |
Price / LTM Sales | 0.55x | 10.98x |
The vast majority of tech companies are sold for less than $100 million dollars. Raising a relatively small amount of money and selling a company for $100 million dollars should be celebrated.
The most important reason why two companies are trading at different PE ratios or EV/EBIT multiples is because of the underlying growth in profitability.
Do high growth companies have high multiples?
As shown, the EBITDA multiples for different industries/business sectors vary widely. There can also be wide disparities within industries or sectors. There are several reasons for these disparities: First, a business with high expected growth will typically have a higher EBITDA multiple.
Many investors find it difficult to invest in the stocks of high-quality, high-growth companies because these companies usually trade at high valuation multiples. In our view, however, they are a reflection of strong fundamentals in the vast majority of cases.
Using Morningstar's price/fair value estimate readings, tech stocks were also well into overvalued territory for most of 2021.
Tech valuations have endured stark declines this year. But after continued selling, it's now possible to argue that the selling has gone too far — that tech valuations are now suffering more than is warranted in the wake of the 2020-2021 tech stock bubble.
Based on this research, the average revenue multiple for startup valuation is 1x – 5x for startups that are growing very slowly (~10% per year), 6x – 10x for startups that are growing in the lower two digits (30-40% per year), and 10x – 20x for tech startups that are growing in the three digits (300-400% per year).