Handbook of Finance: Valuation, Financial Modeling, and Quantitative Tools

Chapter 34. IPO Valuation

KUNTARA PUKTHUANTHONG-LE, PhD

Assistant Professor, San Diego State University

Abstract: Most initial public offerings (IPOs) are young and thus it is difficult to forecast their future cash flow. Moreover, most IPOs do not have any historical data and their value rely on their future growth. Consequently, valuing IPOs is difficult compared to valuing brick and mortar firms. Valuing IPOs is widely implemented by the use of financial information through regression analysis and through comparable firm multiples. Regression analysis incorporates firm and market information. The regression model can be used to predict value of IPOs. Comparable firm multiples rely on finding comparable firms that match IPOs. The most widely used multiples include market-to-book, price-to-sales, enterprise value-to-sales, and enterprise value to-operating cash flow ratios, where enterprise value is defined as the market value of equity plus the book value of debt, minus cash. The use of forecasted financial information and growth of cash flow can improve the accuracy of IPO valuation.

Keywords: initial public offering (IPO), valuation, comparable firm method, regression, underwriters, underpricing, winner's curse theory, signaling theory, prospect theory

Valuing an early-stage company or initial public offering (IPO) is difficult because much of the company's current value depends on expected future revenues from products not yet marketed. Valuing an IPO in a nascent industry is even ...