A stock’s P/E is the present value of all future cash flows discounted back to the present, less net debt, divided by the share count, and divided by next year’s Adj EPS. P/Es are a function of the duration and magnitude of each firm’s future growth rate, long-term interest rates, and the stock’s beta relative to the market. If a company could sustain 30-40% earnings growth rate for 30 years, it could easily command a 150-200x P/E. Unfortunately in most cases, success attracts competitive forces which truncates the duration and magnitude of a company’s “super growth” phase, which reduces its P/E.
Value investors struggle with high P/E stocks not because of their absolute levels, but because they start with the premise that a great company in a competitive industry can’t sustain excess growth for a long enough period to justify that high P/E. Value investors presume reversion to the mean in growth, margins, and returns. Growth investors pray for no reversion to the mean, believing instead that superior products, unique technology, strong brand, or lowest cost operations can stave off that mean reversion. $Tesla(TSLA.US)The copyright of this article belongs to the original author/organization.
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