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.