What Are the Key Factors of a Profitable Business?

The profit model is an enterprise-specific profitable business structure and its corresponding business structure gradually formed in the market competition.

Monetization model

The business structure of an enterprise mainly refers to the transaction object, transaction content, transaction size,

"Wall Street relationship" Peking University Press Author: Peter Sai Ruisi

Although the discount rate has a great impact on the valuation, the risk of the profit model has a greater impact on the valuation. Companies can claim a 20% annual increase in profits, or even explain the reasons for continued growth, but this does not mean that investors will accept these assumptions because many reasons make the results very different from the assumptions. Let's look at some specific examples.

A real estate company rents out properties to long-term credible multinational companies. Based on these leases, a cash flow of $ 2 per year is forecast for the next 20 years. This company should have very consistent profits. Investors will accept these projections if they believe the leases are reasonable and legal.

Another real estate company is building high-end apartments. According to forecasts, the profits from the sale of these apartments over the next four years are $ 2, $ 4, $ 6 and $ 8, respectively. Even if the company's performance is very good and the development projects are good, the profit still depends on the specific situation of this particular market of high-end residential. If the price continues to rise, the company will be able to achieve the forecast; if the price falls, the company can only maintain a break-even or lose money. Investors value the company differently based on their own predictions of the real estate market.

An oil company expects to make a profit of $ 3 from existing wells this year, and newly developed wells will increase profits to $ 6 within three years. Investors will definitely consider the production capacity of existing wells and the production capacity of new experimental wells. Can you prove that these wells will be profitable? Is the company's forecast conservative or optimistic? What is the assumed oil price? Is the company forecasting $ 40 or $ 80? The company may actually make less than $ 6. If the well is dry and the oil price is down, it may only make $ 1; if the well is rich in oil and the oil price is up, it will make $ 10. For an oil company, investors may make different predictions and judge the likelihood of each one. Each investor then makes a different valuation based on their own assumptions about oil prices.

A pharmaceutical company is working on a drug that can treat a major disease. The two trials the company has conducted have been very smooth. It is expected to achieve a gain of $ 20 within 6 years. Investors will study these trials and predict the future of the drug. However, these predictions may be highly volatile, with the risks to consider: drugs may not be licensed, side effects may occur, other more financially powerful companies may develop competitive drugs, and so on. For a pharmaceutical company, investors are likely to give a higher discount rate.

A hospital operating company has reached an agreement with two agricultural provinces: acquiring some local hospitals for a fixed return. After four years, the company will own all the major hospitals in these provinces and cities, and then plan to expand to Beijing and Shanghai. An investor may accept the company's forecast for the first four years, but doubts about the forecast for five years and beyond. Although this company can operate successfully in agricultural provinces, it may not have a competitive advantage in big cities like Beijing and Shanghai.

One company claims to be able to grow its services business by 25% per year at a low price to acquire small competitors. This strategy has two potential risks: first, the acquisition of those competitors is inherently difficult; second, as those competitors continue to grow, the cost of acquiring them will increase. This is another example of discounted predictions.

A retailer has 40 stores, each with a 35% profit margin, and each store's revenue is growing by 18% each year. The company has determined that in the next 5 years, 200 new stores will be established, and the company's annual revenue will achieve 40% annual growth. The development of this company is very simple, the operation of each branch is also very good, and the income is also very high. The risk is that there will be competitors entering this market, and the company's infrastructure must be continuously updated as the company develops. Since the profit model is relatively reliable, it will give this model a moderate discount rate.

Or this retailer, which has the entire market, and now plans to establish new chain stores in related fields. This model will be greatly discounted, because starting a new business is more risky than expanding an existing business.

All the examples above are about specific financial models. In each case, investors judge investment risk based on the company's forecast data in order to make a reasonable valuation. However, there are many other factors that often affect valuations. Here are a few more examples:

A company is doing exceptionally well, but the CEO runs two companies in related industries. Investors worry that the CEO may be distracted by other businesses, so they underestimate the company's profits.

The CEO of a company announced that he would acquire two other companies at 5 times price-earnings ratio. Because the merger will bring business growth to the company, investors may not underestimate profits too much.

The CEO of a company is very good, but the core members of the management team are very few, and the CEO suffered from heart disease three years ago. As investors worry about the health of the CEO, the profit forecast is greatly discounted.

Still at this company, the CEO is very good, and the other management team members are also very good, but investors have never met these people. Although this management team is strong, if investors worry about the health of the CEO and do not understand other senior managers, they will still underestimate the company's profits.

It is still this company that has introduced the entire management team to investors during talks and conference calls. Since investors believe that the company will still perform well even if something happens to the CEO, their discount rate on the company's profits will be much lower.

A company excels in the cable TV industry. The company's CEO is a cousin of the governor, and the government has given the company a lot of preferential treatment. Investors will pay attention to what would happen if the governor stepped down. Because once there is no political "relationship", the company may be revoked. Investors never like companies that rely entirely on government relations.

There are rumors that a company bribed government officials in order to obtain some contracts. Managers explained to everyone that the rumors were false. However, such rumors will always affect the valuation of the company. Although the company can use profits to prove itself over time, these rumors will still linger.

A company's performance has been good, but no one understands its industry. So no matter how good its performance is, investors will underestimate companies in industries they don't understand.

Another company has similar performance, but the industry is undergoing rapid mergers and acquisitions, large Chinese companies are buying competitors at high prices, and foreign companies are looking for opportunities for direct investment. As the company is likely to be acquired in the future, the company's earnings growth may get a higher valuation.

A rapidly expanding company claims to be an Internet search engine portal, surpassing Baidu and Yahoo. Investors are usually interested in companies in high-profit industries, but if the company claims to be able to defeat well-managed, highly competitive opponents, investors will make lower valuations.

The same company claims that Google has bought a 20% stake in it. Because Google's investment in it has made investors confident that it might eventually become a search engine portal, it has now sold for a high price.

A company is profitable for a long time, but the scale is very small. The management team holds 90% of the company's shares, so the company does not have much liquidity. A illiquid company often underestimates profits because of its small size.

There are two companies with identical business fields and performances. One of them has an operator who graduated from Harvard University in the United States and has 5 years of working experience in a multinational brokerage company, while the operator of the other company has not attended a university. Right or wrong, investors will give a high valuation to the first company, because a senior manager who can speak their language and is familiar with Western business operations can give them peace of mind. In addition, the relationship between the operator and the brokerage company is also a great asset.

There are two companies with identical business fields and performances. One employs top international accounting firms and law firms, and the other employs local Chinese accountants and lawyers. In fact, the work of these Chinese accountants and lawyers may be as good as or better than the work of their counterparts in international firms, but investors will give higher valuations to companies that hire well-known accountants and lawyers.

If the company's CEO has not attended college, but the local law firm and accounting firm hired have signed a joint venture agreement with a top multinational company in the industry, the company's valuation will change dramatically. Although investors prefer English-speaking CEOs, they will be more impressed by the company's ability to partner with a well-known international company.

A small company predicts that revenue will grow by 50% annually and will become the leader in the industry in China. But because investors worry that the CEO s predictions will not materialize, the company may never get a better valuation. When an executive sounds too aggressive, investors will be alert.

One company had previously told investors that they were making Chinese herbal medicine. Later, because this business did not develop satisfactorily, the company shifted its business focus to hospital management. The new business may be good, but after a failure, the company should wait to talk about a new situation, because investors are very alert to companies that change business.

A Chinese company has exactly the same performance as an American competitor. The stocks being sold by U.S. competitors are valued at 20 times the forecasted earnings, and the predicted earnings of Chinese companies have to be discounted simply because investors are not yet able to assess their business, management team, or potential risks in China Totally assured. Chinese companies need to maintain stable development for a period of time if they want to achieve a higher multiple.

As you can see from the above example, there are many variables to consider when valuing a company. If a company talks with 10 different investment banks, it may get 10 different valuations.

How does a company determine whether the valuations obtained are appropriate? The following 6 steps should help:

Make three different versions of the 5-year forecast: worst-case, best-case, most likely. Take all assumptions into account, including the cost of acquisitions or additional financing.

Make a lower discount rate assumption for the best situation, a higher discount rate assumption for the worst situation, and a medium discount rate assumption for the most likely situation. This way you get the highest or lowest valuation and a solid medium valuation.

Describe in detail the risks and opportunities that you think exist in the three versions.

Ask your investor relations company to evaluate these three situations, ask them to seriously interrogate the management team for all assumptions, and let them make a model after the investor relations company finishes its analysis.

Study the valuations obtained by other similar companies. Analysts and investment bankers often compare your company with other companies. Assuming that the companies in the same industry have an average P / E ratio of 20 times, if your company grows faster, you can sell 25 times; if your company grows slowly, you can only sell 15 times; if your company If the scale is large and the valuation discount is small, you can strive for a higher valuation; if you are confident in the company's performance, you can fight for a higher price; if you think there are some risks, you need to discount.

See more investors and investment bankers, introduce them to the company, display the prospectus, talk about issues that can affect their judgment, and then ask for a valuation.

After meeting with these investment banks and obtaining a valuation, listen to their reasons for bidding. The mistake of most investment bankers is that they will only tell you something you want to hear. They can only get paid if you raise money successfully, so they're unlikely to say your company is worthless. Nevertheless, their evaluation can help you understand some of the steps you should take before financing.

If investment bankers say you need other lawyers and accountants, you need to prioritize this;

If they are concerned about possible conflicts of interest, explain to them how to resolve these conflicts of interest before financing;

If they say your company should expand a little bit before going public, you can see if your company can make one or two small acquisitions;

If the valuation they give you is much lower than your competitors, you should analyze the reasons and see what measures you can take;

If they complain that they don't understand your financial model, go back and make a simpler version and send it back.

It is important to remember that investment bankers cannot determine valuations, only investors can value them. Investment bankers cannot guarantee that they will be able to raise funds for you, they just do their best. Therefore, while showing them the best situation, it is important to understand all the factors that affect the company's valuation.

"Sunzi's Art of War" states: "Know yourselves and know yourselves, and you will never be overwhelmed."

For a developing Chinese company, continuous financing is the key to sustained high-speed growth. But how can we meet the requirements of international capital markets? How do you know what your "opponents" want to do? The role of investor relations companies is to help you better understand yourself and your "opponents" so that you can develop a strategic plan for successful financing in international capital markets.

If a Chinese company wants to obtain funds in the international capital market, the first task is to find an investor relations company to guide its operations. Investor relations companies can ensure smooth financing processes and ensure that the company can find the best investment banks, analysts, and investors.

All in all, successful investor relations services will help listed companies obtain reasonable stock prices, enhance financing capabilities, build a broad shareholder base, and achieve effective corporate governance. Because investor relations companies are employed by client companies, they represent the fundamental interests of client companies.