The key distinguishing feature of the Chepakovich valuation model is separate forecasting of fixed and variable expenses for the valuated company Unlike other methods of valuation of loss-making companies, which rely primarily on use of comparable valuation ratios, and, therefore, provide only relative valuation, the Chepakovich valuation model estimates intrinsic value. Such companies initially have high fixed costs and small or negative net income. However, high rate of revenue growth insures that gross profit will grow rapidly in proportion to fixed expenses. This process will eventually lead the company to predictable and measurable future profitability. The model assumes that fixed expenses will only change at the rate of inflation or other predetermined rate of escalation, while variable expenses are set to be a fixed percentage of revenues. Chepakovich suggested that the ratio of variable expenses to total expenses, which he denoted as variable cost ratio, is equal to the ratio of total expenses growth rate to revenue growth rate. This feature makes possible valuation of start-ups and other high-growth companies on a fundamental basis, i.e. with determination of their intrinsic values. Other features of the model:
Long-term convergence of company's revenue growth rate to that of GDP. This follows from the fact that combined revenue growth of all companies in an economy is equal to GDP growth and from an assumption that over- or underperformance by individual companies will be eliminated in the long run.
Valuation is conducted on the premise that change in company's revenue is attributable only to company's organic growth rate. This means that historical revenue growth rates are adjusted for effects of acquisitions/divestitures.
Factual cost of stock-based compensation of company's employees that does not show in the company's income statement is subtracted from cash flows. It is determined as the difference between the amount the company could have received by selling the shares at market prices and the amount it received from selling shares to employees.
