Future Profits are Irrelevant for a Business Valuation?

It makes my stomach churn every time I hear it. And I hear it far too often from people that should probably know better. It usually goes something like “but Trevor, your business valuation is wrong…buyers don’t care about future profits, they care about the real figures”.

I’m tempted to stop this article right here because the people that get it will get it and the people that don’t probably never will. But I’ll be patient and optimistic and give it a go.
A few simple examples:
1) Would you buy a lottery ticket for yesterday’s draw? How could you bring yourself to invest in a future draw if you don’t know what the winning numbers are going to be?

2) Would you invest your money in a term deposit with a bank based on it’s interest rates from a year ago, or would you care more about what their interest rates are currently and what you expect them to be over the next year?
3) Would you buy a property off-the-plan before it was built? Are you paying for the sheet of paper with a plan on it or for the expectation of what it will look like when it’s finished? What if the builder might go broke (and many do)?
4) Would you buy shares in a listed company on the stock exchange based on the average of the last 3 year’s dividends or do you care more about the expected dividends and capital gains in the future?
5) Do you marry a person for how unfaithful they’ve been in their past marriage, or based on your expectation of their faithfulness to you in the new marriage? What do you think a mistress does?
6) Surely every start-up business is worth nothing and therefore no one ever has or ever will invest in a business without a history.

I could go on and on about this all day. As investors and has human beings we only care about the future. Sure we still look backwards to see if we can get any clues about the future, but we need to make our decisions solely on the future expectations because the past is already gone.
The Lesson: It’s too easy to say that it’s impossible to predict the future so you can’t use it to make decisions. If that was the case no one would ever buy a business or even get out of bed for that matter. We deal with the risks of forecasting errors every day of our lives and as a business Valuer it’s implicit in every job I do.

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