Because a company’s fundamental value is equal to the sum of its future cash flows, discounted for risks and time value of money, its value will start to fall before peak profit, pricing in the slowing growth and subsequent decline (see Chart 2).
As we have shown in the main article, most IPOs on Bursa reported falling profit almost immediately after listing — when its fundamental value is already on the decline. Why? Founders naturally want to maximise the valuation they can get. When the IPO valuation methodology is a simple PE multiple, the time for listing is at peak profit (IPO price = PE x profit).
During the growth phase, profit is still relatively low, and it makes little sense for the founders to list — they will only get a lowball valuation (similar PE multiple applied on a lower profit base). To raise the funds needed for expansion, they typically turn to private equity and venture capital. These funds then reap all the benefits from the company’s rapid growth stage and rising value (orange line in Chart 2).
Clearly, Bursa will get to share this benefit (rising value) by getting companies to list earlier — before peak profit. But to do so, it must value the company based on its future cash flows, not simply historical profit multiplied by a single PE. In other words, the valuation methodology must assign value to future growth. And yes, at this earlier point, the PE will likely be much higher than the typical 15-20 times multiples we see for most IPO pricings today (see Chart 3). That is fine. What is important is the fundamental value of the company, not its PE. As we said, build a proper valuation model. Drawing more high-growth companies to IPO will translate into stronger average growth and higher valuations for the entire stock exchange — attracting more investors and enhancing liquidity, which further boosts valuations. This is the best way to restore investor confidence in Bursa. Obviously, you need the talent to understand and execute such a strategy.
