Porc,
>>More specifically, to the extent that there are fewer and
shallower recessions in the future than in the past, the future cash
flows coming from cyclical companies will be greater than the average
of past peak-to-peak periods would suggest. <<
It may depend on the individual business, but if it is true that the economy will be less cyclical going forward than it was in the past, it may not change the values at all. At least the way I value businesses.
The typical start to end of business cycle was characterized (for cyclical businesses) with losses or very low levels of return on capital. As the cycle advanced, the losses turned to profits and margins expanded. Late in the cycle, profit margins that are typical of only the most superior businesses prevailed. Levels that could not be sustained by any but the best positioned businesses (of which cyclicals are generally not). Then the cycle busted and we started all over.
My assessment of the value of these businesses has always been to normalize the profitability of the company based the industry, the individual company's position relative to its competitors and all the other factors that are typical of a valuation looking forward. So in general you would be paying a high PE of depressed earnings and low PE of late cycle earnings. The market has done a spectacular job of recognizing this over the decades and has done it.
If the earnings streams now prove to be smoother due to "new era" sorts of management improvements, changes in the economy etc.. the values may be unchanged. The average level of profitability could still be the same over the span of 5 or so years. The PE that is appropriate just need not fluctuate to accommodate the stage of business cycle considerations and varying levels of profitability. So even though you would avoid the period of losses, you would probably also lose the period of obscene profits which occurred for the flip side reason that the losses occurred.
The only way the value would be increased, (by my methodology) is if the entire industry suddenly became more profitable. But that is highly unlikely for the vast majority of businesses since they still face the same competitive pressures they always did and margins get driven to a level that is appropriate. Profits would just be smoother.
Perhaps the market would pay up for that, but I wouldn't and I don't think it should.
I must say that I haven't seen too much evidence of that type of change yet though. Oils, farm equipment, steel, many lines of technology businesses and other manufacturers etc.. are experiencing losses and typical profit downturns even at a time of general heightened prosperity. The financial services business (banks and brokers) were rocked last year and faced staggering losses in the best environment the industry has seen in the history of America. Only the Fed action avoided a complete debacle. So I think the evidence is still not in about the general economy. I also think there are a large number of industries that have yet to be tested.
In any event, since my own methodology is highly related to margin of safety, I would not pay up on the assumption. But that's just me.
Wayne
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