Demystifying the Growth-Adjusted Enterprise Value to Revenue Multiple, and Introducing the ERG Ratio.

Key takeaway

• For entrepreneurs: Understanding the ERG ratio can help entrepreneurs better position their companies for investment by highlighting growth potential relative to revenue.
• For investors: The ERG ratio offers a nuanced way to evaluate SaaS stocks, potentially uncovering undervalued opportunities by factoring in growth rates.

Summary

The article "Demystifying the Growth-Adjusted Enterprise Value to Revenue Multiple, and Introducing the ERG Ratio" by Dave Kellogg introduces the ERG ratio as a modern metric for evaluating SaaS stocks. This ratio, which stands for Enterprise value to Revenue to Growth, is a growth-adjusted version of the traditional EV/R multiple. It helps investors determine whether a stock is undervalued or overvalued by comparing its enterprise value to its revenue and growth rate. The article explains the calculation, potential complexities, and practical applications of the ERG ratio, providing examples to illustrate its use.

Insights

• The ERG ratio is a modern adaptation of the PEG ratio, tailored for SaaS companies.
• It simplifies the evaluation of stocks by adjusting the EV/R multiple for growth rates.
• The median ERG ratio is around 0.3, suggesting that an EV/R multiple should be roughly one-third of the growth rate.
• Stocks with an ERG ratio significantly lower than 0.3 may be undervalued, while those with a higher ratio may be overvalued.
• The ERG ratio can reveal discrepancies in stock valuations that traditional EV/R multiples might miss.

Implications

• For entrepreneurs: By understanding and leveraging the ERG ratio, entrepreneurs can better communicate their company's value to potential investors, especially if their growth rates are high relative to their revenue multiples.
• For investors: The ERG ratio provides a more comprehensive tool for evaluating SaaS stocks, potentially uncovering investment opportunities that are not apparent through traditional metrics. It encourages investors to consider growth rates alongside revenue multiples, leading to more informed investment decisions.