The Effectiveness of Relative Valuation for Firms with Negative Earnings in an IPO Context

Sammanfattning: This paper analyzes a sample of 246 US initial public offerings (IPOs) from 2013 to 2015 containing solely negative earnings firms. The goal is to investigate the effectiveness of relative valuation for loss making firms in an IPO context and comment on whether the results are similar to those recorded for profit making firms in previous studies. This is most relevant, as recent decades have seen a rise in IPO activity along with a change in firm characteristics of newly listed firms. More specifically, an increasing number of companies featuring negative earnings have been able to access the public equity markets. While IPOs are most commonly valued through relative valuation, the effectiveness of multiple valuation for loss making firms has largely been excluded from the existing literature. This paper attempts to fill this research gap. Our results show that overall multiple valuations are similarly effective for loss making as for profit making firms in an IPO setting. In line with relative valuation for positive earnings firms, forward looking multiples outperform trailing multiples for negative earnings firms. Nevertheless, we also find that several widely used multiples, such as the P/E, the M/B and the EV/EBIT multiple, perform poorly across our entire sample. Furthermore, valuation accuracy varies with certain firm types and industries. While the effectiveness is similar to that for profit making firms in an IPO context, the overall valuation accuracy of multiples is relatively low, indicating that within an IPO setting relative valuation should be complemented with other valuation methods.