Yamakita, I'd be glad to respond.
1) The current environment of rapid disintermediation, destruction, and reconstruction of businesses, demands that premium value be awarded to those businesses that "get it" at the expense of those that do not.
Of course this is true. Either you evolve and adapt to a changing environment or you become extinct. The question is
whether the premium is financially justified.
2) The expanding availability (Reach and Richness) of relevant information for investors, is dissolving much of the risk involved in buying great businesses. Since we know that the net present value (share price) of a stream of future cash flows (earnings) grows exponentially with declining discount rates (risks) applied to those cash flows, higher values for the best businesses are a fait accompli.
This is arrant nonsense for a number of reasons.
First, econometric models are notoriously poor at forecasting. Alan Greenspan had some apt comments about the tremendous uncertainty in those models.
Second, much of the earnings visibilty is due to "earnings management", which is a fancy way of saying that the accounting systems of many companies are rigged. The SEC is cracking down on these practices.
Third, the relationship between PV and interest rates is inverse. For example, a perpetuity of $1 with a discount rate of 5% is 20. At a 2.5% rate it is $40, and at 10% it is $10.
Fourth, the writer assumes declining interest rates.
Fifth, there is no relationship between earnings and free cash flow (and FCF is the basis for discounted cash flow analysis).
3) Similarly, the net present values of these companies are exponential with the growth rates of their cash flows, and therefore their PE ratio's logically ought to expand exponentially, and are continuing to do so.
It is quite true that NPV increases with increasing growth rates, but the parameter of interest is free cash flow, not earnings (which are accounting fictions). But the relationship is not exponential. Let me illustrate. Suppose we have exactly four cash flows growing at 10%, and the appropriate discount rate is 5%. So the anticipated future cash flows are $1.10, $1.21, $1.331, and $1.4641. The PV is $4.4994. If the growth rate doubled to 20% the anticipated cash flows would be $1.20, 1.44, 1.72, and 2.0736. The PV of that stream (again using a 5% discount rate) is $5.6476. If the relationship were a simple exponential function, as the post would have you believe, a doubling of the growth rate ought to lead to a quadrupling of the PV. Clearly, this example illustrates that that is not the case.
*****
What you have here is a rationalization of "things are different this time".
TTFN,
CTC |
