I am valuing a construction contractor located here in Northeastern Ohio, where construction activity is way down and will remain that way for many years, barring a miracle. Most authorities expect it to grow perhaps 1% annually on trend, with huge cyclical swings. My client’s revenues ranged from $1.8 to $3.0 million during the last five years, and exhibited no pattern whatsoever. In the middle of the recession (2009), revenues peaked at $3 million, and they dropped to $2.4 million last year. Most of its jobs are very small, lasting maybe a month and contributing no more than 5% of annual revenue. When I asked the owner to estimate 2012 revenue, as expected, he just laughed and said “No way!”
This is a classic case of a business whose revenues cannot be projected with any confidence whatsoever. No willing buyer would believe them or pay for any highly speculative growth; the business’s backlog is maybe 3 months of contracted revenue at any time.
All we can do in situations like this is to look at history and take an average of some sort to estimate a “typical” year’s performance. That’s how a buyer would value the business. This is where the single-period capitalization model is preferable to a multi-period discounting model. We are assuming that the future will be like the past: highly volatile, and that is all we can say about it!