Investors concerned about the valuation multiples of companies today may choose to forego making any investments. They may fear that stock prices will decline toward the longer-term multiple average we’ve seen in decades past.
With interest rates at or near all-time lows, the discount rate used to value equities broadly has dropped. This, in effect, makes all stocks more valuable. That said, the expectations, which are built into equities in general ought to remain top of mind for investors when placing a specific value on a specific stock.
The discount rate one uses to discount the future cash flows of a given company will indeed have decline (a good think for valuations), however, this is only one factor to consider.
Expectations around the long-term growth potential of a company or sector is just as important when on considers the price he or she is willing to pay today for the combined sum total of all future cash flows of a given entity or group.
Making sure one has the appropriate conservative estimates for growth, as well as a buffer to account for various potential shocks and bumps along the way is important.
I think we’re about to see a period of time in which growth underwhelms investors, and would encourage a conservative approach to plugging these expectations in to one’s personal valuation model.
Invest wisely, my friends.
