Valuing high technology growth firms
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Valuing high technology growth firms Jan Klobucnik • Soenke Sievers
Ó Springer-Verlag Berlin Heidelberg 2013
Abstract For the valuation of fast growing innovative firms Schwartz and Moon (Financ Anal J 56:62–75, 2000), (Financ Rev 36:7–26, 2001) develop a fundamental valuation model where key parameters follow stochastic processes. While prior research shows promising potential for this model, it has never been tested on a large scale dataset. Thus, guided by economic theory, this paper is the first to design a large-scale applicable implementation on around 30,000 technology firm quarter observations from 1992 to 2009 for the US to assess this model. Evaluating the feasibility and performance of the Schwartz-Moon model reveals that it is comparably accurate to the traditional sales multiple with key advantages in valuing small and non-listed firms. Most importantly, however, the model is able to indicate severe market over- or undervaluation from a fundamental perspective. We demonstrate that a trading strategy based on our implementation has significant investment value. Consequently, the model seems suitable for detecting misvaluations as the dot-com bubble. Keywords Schwartz-Moon model Market mispricing Empirical test Company valuation Trading strategy JEL classification
G11 G12 G17 G33
J. Klobucnik (&) Cologne Graduate School in Management, Economics and Social Sciences, University of Cologne, Richard-Strauss-Str. 2, 50931 Cologne, Germany e-mail: [email protected] S. Sievers Accounting Area, University of Cologne, Albertus-Magnus-Platz, 50923 Cologne, Germany e-mail: [email protected]
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J. Klobucnik, S. Sievers
1 Introduction Web based social networks such as Facebook, Twitter and so forth are currently one of the fastest growing industries and therefore attracting investors’ attention. Recently, Facebook went public as the second-largest US IPO of all time, implicitly valuing this company at around $100 billion. The result was a market capitalization higher than for mature internet firms as Ebay or Amazon.1 While Facebook’s IPO currently dominates the media, its social network game development company Zynga, the deal-of-the-day website Groupon and the music recommendation service Pandora went public in 2011 with corresponding firm values of $13 billion, $7 billion and $2 billion, respectively, although still making losses.2 Hence, the challenging exercise of valuing fast growing technology firms is becoming popular again despite the recent financial crisis. In response to the demand for a valuation model suitable for such firms, Schwartz and Moon (2000, 2001) develop and extend a theoretical model explicitly focusing on the value generating process in high technology growth stocks. It is based on fundamental assumptions about the expected growth rate of revenues and the company’s cost structure to derive a value for technology firms. Using simple Monte Carlo techniques and short term historical accounting data, the SchwartzMoon model simulates a growing technology fi
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