722  High-Growth Companies
estimates on transaction counts were revised downward (see Exhibit 36.10).5 
The company had five times the volatility of the S&P 500 during its first two 
years of trading.
As Farfetch’s prospects begin to stabilize, however, it should be possible 
to tighten the range of potential outcomes. These gains in precision should be 
reflected in a decrease in the stock’s volatility.
The challenge of accurate valuation is not limited to Farfetch. We exam-
ined the total shareholder returns for more than 800 initial public offerings 
since 2010. Only 112 of the 838 IPOs earned between 7 and 12 percent, a range 
many consider the fair rate of return for investing in equities. Instead, inves-
tors either made or lost much more than anticipated. In fact, nearly 10 percent 
of IPOs either generated or lost 50 percent of their value since going public.6
A great deal of uncertainty is associated with the problem of identifying 
the eventual winner in a competitive field. History shows that a few players 
EXHIBIT 36.11  Distribution of Annualized Total Shareholder Returns for U.S. IPOs
Number of companies
< –52
–52 to –47
–47 to –42
–42 to –37
–37 to –32
–32 to –27
–27 to –22
–22 to –17
–17 to –12
–12 to –7
–7 to –2
–2 to 2
2 to 7
7 to 12
12 to 17
17 to 22
22 to 27
27 to 32
32 to 37
37 to 42
42 to 47
47 to 52
> 52
27
12
16
16
19
19
25
26
42
42
61
72
114
112
59
45
43
23
14
13
9
6
23
Note: Total shareholder returns for 838 initial public offerings (IPOs) between 2010 and 2017. Returns are measured from the first day of trading through December 
31, 2019.
5 In August 2019, Farfetch announced the acquisition of New Guards Group, an Italian brand platform 
that operates a portfolio of luxury fashion labels. The company purchased New Guards to further 
differentiate its product portfolio and capture a greater share of the online market, but some analysts 
expressed concern about a potential shift away from the company’s asset-light third-party model. At 
the same time, Farfetch lowered near-term GMV forecasts to reflect a decrease in promotional spend-
ing. We believe that our four scenarios, modeled earlier in the year, still ring true, albeit with a greater 
probability for the less favorable scenarios than when originally created.
6 The results come from Corporate Performance Analytics by McKinsey, which relies on financial data 
provided by Standard & Poor’s Compustat and Capital IQ.

Summary  723
will win big, while the vast majority will toil away in obscurity. It is difficult 
to predict which companies will prosper and which will not. Neither investors 
nor companies can eliminate this uncertainty; that is why advisers tell inves-
tors to diversify their portfolios, and why companies do not pay cash when 
acquiring young, high-growth firms.
Summary
The emergence of Internet, mobile, and other technology companies has cre-
ated impressive value for some high-growth enterprises. It has also raised 
questions about the sanity of a stock market that at times has appeared to 
assign higher value to companies the more their losses mounted. But as this 
chapter demonstrates, the DCF approach remains an essential tool for under-
standing the value of high-growth companies. You must adapt your approach 
when valuing these companies: start from the future rather than the pres-
ent when making your forecast, think in terms of scenarios, and compare the 
economics of the business model with peers. Though you cannot reduce the 
volatility of these companies, you can at least understand it.

725
37
Cyclical Companies
A cyclical company is one whose earnings demonstrate a repeating pattern 
of significant increases and decreases. The earnings of cyclical companies, in-
cluding those in the steel, airline, paper, and chemical industries, fluctuate 
because the prices of their products change dramatically as demand and/or 
supply varies. The companies themselves often create too much capacity. Vol-
atile earnings within the cycle introduce additional complexity into the valua-
tion of these cyclical companies. For example, historical performance must be 
assessed in the context of the cycle. A decline in recent performance does not 
necessarily indicate a long-term negative trend, but rather may signal a shift 
to a different part of the cycle.
This chapter explores the valuation issues particular to cyclical companies. 
It starts with an examination of how the share prices of cyclical companies 
behave. This leads to a suggested approach for valuing these companies, as 
well as possible implications for managers.
Share Price Behavior
Suppose you were using the discounted-cash-flow (DCF) approach to value 
a cyclical company and had perfect foresight about the industry cycle. Would 
the company’s value and earnings behave similarly? No. A succession of DCF 
values would exhibit much lower volatility than the earnings or cash flows. 
DCF reduces future expected cash flows to a single value. As a result, any 
single year is unimportant. For a cyclical company, the high cash flows cancel 
out the low cash flows. Only the long-term trend really matters.
To illustrate, suppose that the business cycle of Company A is ten years. 
Exhibit 37.1, part 1, shows the company’s hypothetical cash flow pattern. It is 
highly volatile, containing both positive and negative cash flows. Discounting 
the future free cash flows at 10 percent produces the succession of DCF values 
in part 2 of the exhibit. Part 3 compares the cash flows and the perfect-foresight