The Math of Value and Growth

June 09, 2020

The Math of Value and Growth

Consilient Observer

The Math of Value and Growth

June 09, 2020

We show how corporate valuations change as we vary assumptions about growth, return on incremental invested capital, and the discount rate.

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.
We focus on how changes in growth rates can affect P/E multiples, the idea that companies with substantial and attractive current investment opportunities lengthen their duration, and why the distinction between growth and value is muddled.
It is important to remember that returns on invested capital eventually drift lower due to factors such as competition, maturation, obsolescence, and disruption.
Long-duration assets are very sensitive to changes in the discount rate. In an environment of low expected returns, the stocks of companies with long-term investment opportunities are worth substantially more than they were in an environment of higher expected returns.

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