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How Would You Beat Your Equity Value?

 

In this latest episode of the How Would You Beat podcast, we looked at how companies can beat their equity value multiple. We explored the connection between the value of a company’s equity and its growth (or at least its growth story, or the promise of growth). This raised some interesting questions such as “what is the risk in pursuing a new growth story or a new product?”, “why would you want to kill your present product if it generates revenue?” and “how should companies pursue growth”? 

Let’s dive deeper.

The connection between growth and equity value 

Companies exist to create value for different stakeholders. Your stakeholders include customers, communities, employees, and shareholders. Among these, shareholder value has witnessed tremendous attention over the decades. 

Shareholder value or equity value is the value of a company as you see it on the stock market. For private companies, equity value translates to the amount that an individual or firm would be willing to pay for your company. 

Private or public, a company’s equity value stems from its profitability and growth. It, therefore, boils down to your ability to create customer value because customer value drives profitability, which drives improved cash flow and growth. When a company is valued, cash flow, profitability, and growth rate are the critical components to the valuation. 

The significance of growth rate in the equation stems from the fact that when someone is looking to buy a company or even just a share of a company, they discount the profits earned over time to the present day. When investors are looking at cash flows - or what Warren Buffet calls owner’s earnings - they are simply asking whether they are paying too much or too little for the current growth rate. 

For example, if a company is set to be bought for $200 million and it delivers $100 million in revenue, the buyer is investing at a revenue multiple of 2. The buyer might not mind paying a higher price because of the promise of growth. This is where companies have the opportunity to improve their equity value based on the growth story they can tell. 

Some companies fire many employees or sell assets to improve the company’s balance sheet. This maneuver only temporarily makes the balance sheet look strong. Real growth and sustainable profitability come from expanding your market share and earnings. 

Companies like Amazon and Tesla might not have the same level of profitability as some of their competitors, but they inspire confidence that they will achieve a growth rate in the long term. Investors are buoyed by this promise of future growth and might not mind paying a little more for Amazon’s shares, for example, because they look forward to reaping the benefits of the company’s growth rate in the long term. 

The risks and opportunities in pursuing growth

Of course, the risk of investing money into innovation that drives growth is that the product could fail. If the product roadmap does not lead to growth, it can destroy equity value because the investment not only fails to improve revenue but it also increases expenses, damaging the profit on both sides of the equation. The company would be better off stopping new product development altogether.

So how do you achieve a risk-mitigated growth thesis? By researching the market sufficiently and, more than anything, by identifying unmet needs. Your new product must solve a problem that many people need solving.  Further, your target audience needs to be willing to pay a good amount of money to solve the problem, or at least enough money for your innovation to be profitable. The idea that you will satisfy a need that customers don’t know they have is a far riskier proposition than satisfying a need that is top of mind with your customers.

Nest is a good example of a company that focused on the true customer’s unmet needs and found a large market opportunity that the incumbents missed. In the process, they changed the game in the thermostat market. Before Nest, the market size for thermostats was - according to research companies - small because the brands and research companies involved were looking at how many people would buy a thermostat.  At the time, thermostats sold for USD 30 apiece, and thermostat companies sold thermostats to HVAC companies who fitted the thermostat into your wall - nobody knew how to program the device, and nobody ever used it the right way. Nest identified unmet needs in the market and zeroed in on the right customer: the homeowner. Nest decided to sell comfort and to address their marketing directly to buyers rather than via HVAC companies. They managed to push the price for their thermostats up to about USD 250, nearly ten times as much as buyers previously paid for a thermostat. The point is, Nest wasn’t selling thermostats; they were selling comfort. And they went directly to what we call the ‘job beneficiary’ or the homeowner. 

When you are looking to disrupt the market with innovation, expect incumbents to dismiss you, saying that there's no way the market will tolerate the price point or usability you are pursuing. But if you target the right customer, the right job-to-be-done, and the unmet needs in the job, you can prove them wrong. 

How companies and product teams should pursue growth

Imagine that your company or product team is sitting on an idea that has the capacity to become the next Google or Amazon. Great, but you also need to be convincing enough to get your idea funded or the political capital to get your idea prioritized. A convincing growth thesis that outlines a clear target segment with an unmet need helps you gain the support you need. 

Your growth thesis should outline how much the target segment will be willing to pay to get the job done and whether this will be enough to assure profitability.  

If you want to learn more about thrv and our Jobs-to-be-Done approach, be sure to sign up for our free course.

 

Posted by Jay Haynes

View all posts by Jay Haynes