Balancing growth and profitability is essential for long-term value creation and success in AEC firm valuation strategies.
I have often complained here and elsewhere about those financial “experts” who only want to use historic EBIT as the basis for determining value in an AEC firm. I think it shows a real naivety to just look at EBIT. It makes sense in some cases. But it doesn’t make sense in all cases. Where it makes sense is when you have a flat or low growth company that consistently spits out profits. High growth companies are a completely different matter.
I was part of a discussion recently with a very successful, big-time investment banker in the course of helping two companies work together for a potential merger, and had a chance to ask him some questions about this. He had a simple answer. If the firm’s growth rate is less than 20 percent, multiples of EBIT as a basis of value make sense. Once the growth rate exceeds 20 percent, that goes out the window. I have always liked to use 30 percent as a target for combined growth rate and profitability, and have written about that in these pages in the past. Any company that can do that or better year-over-year will blow the lid off any traditional valuation multiples.
The public market reflects what I am talking about. Look at how long it took Amazon to be profitable yet they had incredible value. Why? Revenue growth rate. Plain and simple. And this is just one of hundreds or thousands of companies that were not profitable yet had stocks that were highly valued.
Don’t get me wrong. I’m not saying profits aren’t important. Businesses have to make a profit at some point or there is something fundamentally wrong with them. But at the same time, growth is where the real value creation occurs and where the real opportunity lies for investors.
I’m an owner and board member in a company that is not in the AEC business. I am also on their valuation subcommittee. We set the value of the stock each year that governs all stock transactions. This year, we are going to be looking at financials that show the company lost money in 2024. A multiple of EBIT valuation would give us a value of zero. Yet the company grew by more than 30 percent in 2024 and has a forecast to grow by 50 percent in 2025, all while operating in a flat market for what they sell. At the same time, the balance sheet improved significantly from 2023 over the course of 2024 because of new equity injections and debt reductions. On top of it, lots of money was spent on research and development that will lead to new revenue sources. So the valuation has to reflect this performance. While not profitable, it’s heading in the right direction. At some point when revenue is high enough, the firm should become very profitable. Will that (high profitability) happen in the coming year? Probably not. Will the revenue increase (if it happens) get the firm in the black? It probably will. Does that set the stage for more growth and even greater profits in 2026? I think it will. So the value is there as long as the investors have a long range perspective.
So much of success in the AEC business – or any privately-held company –depends on the owners having a long-range perspective. A fixation on short-term profitability is the opposite of this. Any company in our business can be profitable in the short-term. All you have to do is cut costs and stop investing in people, R&D, and marketing. You should be profitable! But at what cost? And how long will that last? And what are you giving up in terms of value creation that you could have achieved had you been more focused on growth?
The truth is it takes balance. You need enough profitability that you have positive cash flow and don’t have to constantly raise more equity to stay in business. But you also need a viable growth strategy and patient investors with a long-term perspective who understand why reinvesting in growth is where the real opportunity lies.
So what is your strategy in 2025? Growth? Or profitability? What is your goal for combined growth rate and profit percentage? Are you being ambitious enough? Do you and your partners understand how growth rate impacts the value of your company? Or are you letting the nickel get so big it hides the dime sitting behind it?
Mark Zweig is Zweig Group’s chairman and founder. Contact him at mzweig@zweiggroup.com.
