A recent in-depth study on how to make better investment decisions came to the following conclusions:
In-depth industry knowledge and endless company-specific research work („Inside view“) alone are not enough for accurate forecasts. You also need accurate knowledge of what has happened in similar decision situations in history („Outside view“). For example, an entrepreneur or investor can, based on his in-depth industry knowledge and research, predict that M&A target will grow very quickly and for a very long time in the future.
However, based on the conclusions of the report, this is not enough, and the forecast of the success of the M&A target should also take into account how other companies have grown in similar situations in history.
If it has been rare, based on historical data, that companies grow really fast for a really long time, then the acquisition target’s forecasts and especially valuation should take these into account.
For example, according to the study, only 2% of the companies in their extensive database grow by approx. 20-25% per year for 10 years. Considering how rare it is for companies to have fast, long-lasting growth, entrepreneurs and investors should take this into account and adjust valuations of acquisition targets accordingly. In addition, entrepreneurs and investors (and their advisors) should think how much weight optimistic management forecasts should have in their decision making.
Post by Turo Kiiski, 3J PARTNERS