Investing in speculative start-up stocks? 14 alternative fundamentals to follow

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There are lots of ways to measure things and how they might grow.

© Georgii/stock.adobe.com; Photo illustration Encyclopædia Britannica, Inc.

You just bought shares in a hot new company whose stock price, you believe, has the potential to go sky-high. As a responsible investor, you now have to do your homework by regularly evaluating the company’s fundamentals.

But then you hit a snag, because traditional stock metrics don’t work.

Does this mean you’ve invested in a bad stock? That, of course, depends on your objectives, risk tolerance, and time horizon. But you’re probably looking at the wrong fundamentals. Here are 14 alternative fundamentals to consider when the traditional ones aren’t appropriate.

What is it? Ever wonder how much a company would make if it captured 100% of its market share? This metric tells you the monetary worth of the entire global pie.

How to use it: This benchmark figure tells you the sheer size of a company’s total market opportunity. The company isn’t likely to capture all of it, but it can take a good chunk if it’s successful and/or first to market.

How to calculate it: TAM = (total number of potential customers) x (average revenue per customer)

What is it? SAM focuses on market share that’s within a company’s geographical reach. This metric is more relevant than TAM if a company is targeting its regional market before attempting to compete on a global scale.

How to use it: SAM gives you a more realistic picture of what a company can achieve if it decides to target regional markets first.

How to calculate it: SAM = (TAM) x (percentage of TAM within a company’s reach)

What is it? For some companies, the serviceable addressable market (SAM) may still be too large a target. So the company will likely focus on just a portion—its serviceable obtainable market, or SOM.

How to use it: Once you have a more realistic picture of what a company can achieve in market share, you can use it to forecast its growth potential and assess its market performance.

How to calculate it: SOM = (SAM) x (realistic market share percentage)

What is it? For companies that rely on subscriptions, the MRR tells you the predictable monthly income from subscriptions and/or contracts; essentially, any recurring revenue streams.

How to use it: Because this income occurs monthly, you can use it to forecast a company’s growth and assess its revenue stability.

How to calculate it: MRR = (number of subscribers) x (average revenue per user per month)

What is it? How much does it cost for a company to get new customers? The CAC breaks this down for you.

How to use it: This metric can help you determine whether a business’s strategies to acquire new customers are efficient.

How to calculate it: CAC = (total sales and market expenses) / (number of new customers)

What is it? This metric forecasts the total revenue a customer will generate over their entire lifespan of engaging with the business.

How to use it: You can use this to estimate a company’s long-term profitability based on its customer revenues. However, this also requires some historical data, which may be inadequate for new businesses.

How to calculate it: LTV = (average revenue per unit per period) x (gross margin per customer) x (average customer lifespan)

What is it? If you’re curious about the percentage of customers who drop a company’s product or service over a given period, that’s what the churn rate is all about.

How to use it: Use this to analyze customer retention and whether they may be satisfied with a company’s products and services.

How to calculate it: Churn rate = (number of customers lost during a period) / (total number of customers at the start of the period)

What is it? This metric tells you how much of a company’s cash reserves are being spent to cover operating expenses before it achieves positive cash flow.

How to use it: You can use the burn rate to forecast whether a business will run out of cash before it gets a chance to sustain itself through recurring revenue. Does it have enough reserves, or will it have to raise capital through investors or loans?

How to calculate it: First you need the gross burn rate, which is the same as the total monthly operating expenses. Net cash burn rate = (total monthly operating expenses) – (monthly revenue)

What is it? Net promoter score, or NPS, is a metric that attempts to measure customer satisfaction and customer loyalty by asking if they’d recommend the company’s products to others.

How to use it: Every business aims for a steady stream of customers. Repeat customers are even better. But if a business can turn customers into brand promoters and influencers, the “word-of-mouth” benefits can serve as a real force multiplier for its marketing. NPS is a look at the early stages of converting customers into a brand tribe.

How to calculate it: NPS = (percentage of promoters) – (percentage of detractors)

What is it? Gross margin, a percentage-based figure, is the remaining revenue after subtracting a company’s cost of goods sold (COGS). It answers the question, “How much is a business taking home after all expenses are accounted for?”

How to use it: It can help you analyze a company’s efficiency from the angle of its cost of production.

How to calculate it: Gross margin = ((revenue – COGS) / revenue) x 100

What is it? The viral coefficient metric analyzes the organic growth rate a business may experience through customer referrals.

How to use it: What’s exciting about this metric is that you can see if a company is growing incrementally or exponentially through customer referrals. Either way, it can tell you a lot about customer satisfaction, the company’s marketing strategies, and whether it’s generating enough buzz to be the “next big thing” in its market.

How to calculate it: Viral coefficient = (number of invites sent per customer) x (conversion rate of new customers)

What is it? This is a key performance indicator that compares a company’s current financial performance—in one or several metrics—to the same time a year ago. Growth is typically expressed as a percentage.

How to use it: You can track the growth in earnings per share (note that could mean a lower net loss versus the previous year), growth in net revenue, or even growth in market capitalization.

How to calculate it: YoY growth = ((current year’s value – previous year’s value) / previous year’s value) x 100

What is it? Ever wonder how much revenue a company is making relative to the number of employees it has? This metric calculates that figure by dividing a company’s total revenue by the number of its employees.

How to use it: Assess whether the business might be producing too little for the size of its workforce. In the opposite scenario, where a company is producing a lot with just a few workers, you might be able to forecast its growth if it should increase its head count.

How to calculate it: Revenue per employee = (total revenue) / (number of employees)

What is it? This metric tells you whether a start-up is burning cash too quickly or spending it efficiently.

How to use it: The net cash burn rate (discussed earlier) can help you determine whether a business is going to survive financially before it turns a profit. The burn multiple can help you assess a start-up’s potential for longer-term growth by evaluating how efficiently it converts its cash burn into revenue.

How to calculate it: Burn multiple = (net cash burn) / (annual recurring revenue)

In the absence of hard sales and profit data (which most start-ups simply don’t have), traditional metrics don’t tell a company’s story. Even among the alternative measures, some may take priority, depending on the company and industry. Some industries have their own preferred metrics—for example, a social platform might track daily (or monthly) active users.

But at some point, a company is going to be expected to turn a profit if it hopes to remain viable. And for every success story, such as Amazon (AMZN)—which didn’t turn its first annual profit until year 10—many others never get over the profitability hump. When the business cycle turns from boom to recession, such companies frequently file for bankruptcy.

Follow the alt fundamentals and invest if you see promise, but also follow economic trends and figure out where the “smart money” seems to be moving. If it looks like your start-up could be sputtering, make sure you’re not among those left holding the bag.