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Michael Mauboussin: From Multiples To Value Drivers

In his latest article titled The Math of Value and Growth, Michael Mauboussin explores the relationship between growth, return on capital, and the discount rate in valuing financial assets.

The document emphasizes that most investors use multiples such as P/E for valuation, which can obscure the underlying drivers of value. Michael argues that the distinction between value and growth stocks is often misleading. The focus should be on value-creating growth, where the return on investment exceeds the cost of capital. He also highlights the importance of understanding how changes in growth rates, return on invested capital, and discount rates affect valuations.

Here are the key topics covered:

  • Asset Valuation: The value of a financial asset is based on the present value of its future cash flows, considering the timing and magnitude of these cash flows and the discount rate.
  • Growth and Value Creation: Growth should lead to value creation, meaning investments must yield returns higher than the cost of capital. Large markets with high returns are ideal but attract competition, making barriers to entry crucial.
  • Intangible Investments: Modern investments often involve intangible assets, which can initially show poor profits but create significant value over time.
  • Valuation Multiples: Investors often use multiples like P/E for valuation, but these can obscure key drivers such as growth, return on invested capital, and discount rates.
  • Interest Rates and Duration: Low interest rates can imply high asset values but may also indicate slow growth. Duration, or the time to receive cash flows, affects sensitivity to interest rate changes.

Most investors value stocks using multiples and also seek to distinguish between value and growth stocks. But these practices obscure the important drivers of value, and very few investors have a clear sense of how revisions in expectations for those drivers change multiples.

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Disclaimer of liability

The above has been prepared by Børsgade ApS for information purposes and cannot be regarded as a solicitation or recommendation to buy or sell any security. Nor can the information etc. be regarded as recommendations or advice of a legal, accounting or tax nature. Børsgade cannot be held liable for losses caused by customers’/users’ actions – or lack thereof – based on the information in the above. We have made every effort to ensure that the information in the above is complete and accurate, but cannot guarantee this and accept no liability for errors or omissions.

Readers are advised that investing may involve a risk of loss that cannot be determined in advance, and that past performance and price development cannot be used as a reliable indicator of future performance and price development. For further information please contact info@borsgade.dk

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