Valuations are generally at an equivalent of what you would get investing the money elsewhere. For example, if you believed you could get 5% on your money elsewhere, you may be willing to value a company at 20x it's profit (price to earnings).
In cases where the market is growing then you may be willing to give a higher multiple in the belief that your future returns will be higher. In cases where there is high growth and little profit, some investors choose to use a multiple on revenue instead. Revenue multiples of 5x-20x are pretty common for high growth companies. (Price to Sales)
I am leaving risk adjustment out of this explanation on purpose, but if you are interested look up "efficient frontier".
I understand this concept, but never heard it explained quite this way. Thanks for this concise example and especially for the connection with the "efficient frontier".
In cases where the market is growing then you may be willing to give a higher multiple in the belief that your future returns will be higher. In cases where there is high growth and little profit, some investors choose to use a multiple on revenue instead. Revenue multiples of 5x-20x are pretty common for high growth companies. (Price to Sales)
I am leaving risk adjustment out of this explanation on purpose, but if you are interested look up "efficient frontier".