Tech Valuation Trends to Watch in 2016

Profitability

The end goal of any business is (or should be!) to generate profit. There are two primary measures of profitability to focus on — gross profit (revenue less costs directly tied to producing the good/service) and net profit (gross profit less other costs such as marketing or R&D).

Cash Flow

Cash is the fuel that all companies run on and so a negative cash flow can only be sustained for so long. Companies that run persistent free cash flow deficits are likely to be heavily punished by the markets. There is some evidence that this is already happening, Box has seen its value cut in half since its IPO despite healthy gross profit margins of 70% and growing revenue 10% per quarter. Box’s free cash flow to revenue ratio is -0.47, meaning that for every dollar of revenue it looses 50 cents in cash. To compound this, Box can only sustain this level of negative free cash flow for less than 18 months before it will need a cash infusion.

Efficiency

The major impediment in converting revenue into profit is operational efficiency — ie what levels of costs relative to revenue does it take to maintain the business in its current state. Two useful benchmarks of operational efficiency are revenue per employee and Sales/Marketing/Admin expenses to revenue.

‘Legacy Tech’ Benchmarks

A notable feature in the early 2016 tech stock selloff was the resilience of legacy tech companies (ie mature tech companies whose growth has plateaued and are generating profits such as Oracle, Microsoft, IBM). Since 2014 the Enterprise Value/Revenue ratio of legacy tech companies has steadily increased whilst that of Saas companies more than halved.

Legacy Tech and Saas
  • Gross Profit Margin : 63%
  • Net Profit Margin : 13%
  • Free Cash Flow/Revenue : 24%
  • Revenue Per Employee : $340,000

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.NET developer, splitting my time between Hong Kong and Sydney and trying to live the endless summer.

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Jude O'Kelly

Jude O'Kelly

.NET developer, splitting my time between Hong Kong and Sydney and trying to live the endless summer.