How to value growing firms

Some metrics don’t work if there are no earnings

Question: Typical valuation metrics like the P/E ratio don’t really work for fast-growing companies with no profits. What should I use instead?

Answer: Rapidly growing companies can make for some pretty lucrative investment opportunities. As one example, Tesla’s stock is up more than 2,000 percent since its 2010 IPO, despite that the company has yet to produce a fullyear profit. However, this lack of profitability can make them difficult to value.

There are several metrics to value stocks without earnings. One method I like to use involves a combination of a company’s price-to-sales ratio and its revenue growth rate.

One of my favorite high-growth companies that has yet to turn a serious profit is Square. The company has a market capitalization of $21.8 billion, and its second-quarter revenue, when annualized, translates to a price-tosales ratio of 14.2. Square’s adjusted revenue grew by 60 percent over the past year.

Yet-to-be profitable social media company Snap trades for a price-tosales ratio of 11.5 based on its annualized second-quarter sales and just reported 44 percent revenue growth. So this is a good example of how one of these variables can offset the other.

Even if a company doesn’t have earnings, there are plenty of metrics you can use to get a pretty thorough picture of its valuation.

Matthew Frankel owns shares of SQ. The Motley Fool owns shares of and recommends SQ and TSLA.