Check if the TAM - Total Addressable Market ( The amount of customer or business one can do with his/her product)
Assume the TAM for one's product is $50 billions and the founder thinks his company can capture 10% of it in 10years
Then build the model building using excel.
Let's now find out what his sales is??
let's just say the average selling price, the product that this company is making, the average selling price of the ASP is $100,000. And so if we take $5 billion in revenue divided by $100,000 per unit, or the average price, then that gets you to 50,000 units sold in year 10.
We only care about revenue.
So, logically this is how the sells should be:
I'm forecasting the year over year growth in the number of units, and so by year 10 you see that they're expecting 50,000 units, and I'll just kind of walk through it until I get the right numbers set up,
and I'll always list everything I'm thinking about as I go through this process, so when I revisit my model I can understand the logic that was in my head at that time.
Okay, so I'm gonna read some of the line items off of my Excel spreadsheet here. So in year three, our guy said he can get to $500 million in revenue, hmm, this seems pretty aggressive. Let's assume it's $400 million.
Now
Okay, so here's where I'm at right now. So, 50,000 units in year 10, I'm at 51,000 now. In 2015 there's 20 units coming to launch then,
200 the next year, then four grand, then 2018 that got 8,400, and then you can see the year over year growth there, which is high. It's still way too high. Look at that triple digit year over year growth there in year 2020 through 2024, unrealistic, unrealistic. But the reason I'm showing this slide is because
I want to show you that the revenue line item is, quite simply, the number of units multiplied by the average selling price of 100 grand.
So I wrote here, again, there must be competition at some point, so we have to haircut the average selling price. So we'll assume competition enters the market in three years, and at that point the price drops from 100 grand down to something else.
So we'll assume competition enters the market in three years, and at that point the price drops from 100 grand down to something else. And so I did it right here, you see that, actually by the end of the third year and into the fourth year, I assume that the pricing point is no longer $100,000.
It actually drops to $90,000. That's why I multiply it by 0.9.
Okay, so we took a haircut pricing wise.
NOTE: $100 Grand was our ASP
And then I assume that by year 10, or 2024, whatever it is, you get a 40% price cut.
What about Expense??
So for this company
we have a cost of goods sold model out there as 10% gross margins (GM).
And it goes down to 60% or it goes up to 60% in 2018.
Higher is better because you're making more gross margin profit on that item.
You add sales and marketing that's S&M, general administrative that's G&A, and then R&D, which is research and development. And almost all companies have these three lineups,
Okay, so we don't really put it in tax until year three because we weren't profitable until year three.
say you lost 20 million bucks in year one and year two, you can carry that forward and you'll never pay taxes until you make up for that $20 million in losses.
So that means that the first $20 million going forward, for example, in taxes you're supposed to pay, you're not paying them.
They're carried forward. Those are called NOLS or net operating losses.
I wanted to make this a very quick study for you. So I ask now is the $350 million valuation that we paid from a venture capital perspective to invest in this company attractive or not?
you might not know for quite some time, but people are usually growth or value on that spectrum.
And if you're stuck in the middle, then that's called GARP or growth at a reasonable price.
And so venture capital investors and tech investors are growth investors. And people that like to buy stuff that's cheap, meaning outside of tech, are value investors.
And all great companies in technology go from growth, and then when they mature, remember the last stage, remember the red bar with a shark, when large companies or tech companies, when growth slows they mature, they transition from growth slowly to value.
And that transition when these companies are big and mature takes at least 10 years. And that's purgatory from an investing perspective.
Why?
Because growth investors won't touch the stock because it's not growing fast enough. And value investors won't touch the stock because it's not cheap enough.
And our value investors who value based on earnings are paying 10 times earnings in five years.
So 2020, roughly at that point in time, the company will be valued at $5 billion or 10 times $500 million in earnings. Great.
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