The sexy little g
Of course, I’m talking about growth…because I’m a finance geek. Somehow growth has become the all-important factor in determining the attractiveness of a stock.
Case in point: according to Fortune (April 2, 2007; p. 114), the top 100 US stocks by market cap are selling at 14 times earnings, the companies that rank from 501-1000 in capitalization sell at 21 times earnings, and the companies that rank from 1,001-3,000 sell at 28 times earnings.
It’s the anti-nifty 50. Large, safe companies are selling at historically low prices while small, risky companies are selling at huge premiums. Why? The sexy little g.
At some point this will change and we’ll start hearing about the relative safety of larger companies. The funny thing is: nothing will have changed. The basic valuation equation never changes, even though different parts of the equation are emphasized from time to time.
The basic valuation (constant growth) model is:
(Cash Flow next year)/(Discount Factor - Growth)
Since the Discount Factor is a function of risk, the value of the firm is determined by both the safety and the growth. Today, every other article is about the growth prospects of a stock. Over time, this will change and we will be inundated with articles stressing the safety of an investment.
I have a suspicion that those seduced by the sexy little g today will be waking up with regrets the morning after.
