Market implied growth rates

[learningfromgiants]

I run watchlists using the rearranged Justified Price to Book Formula to calculate historical, current and consensus implied market earnings growth rates. It is crude, but very interesting. 
 

What I am noticing at the moment is that that as rates in the 10 year have blown out that current prices for many US , especially large cap, names are pricing in abnormally high growth rates, seemingly due to too low cost of capital. This assumes that rates stay flat, which I don’t think is unreasonable given that this was the norm earlier on the 2010s and the 2000s.

 

I am curious whether anyone else is finding that prices in general are still not reflecting the new normal for cost of capital? Many analysts out there are still pricing off of 5 year average multiple ranges, which just seems ludicrous given how the risk free rate has moved. 
 

Any thoughts (especially contrary) would be greatly appreciated! 

 

[scorpioncapital]

Is growth rate dependent on human or physical capital for all companies?

cost of capital only usually applies to physical capital.

related to this, growth rate may not be held back hence the elevated pricing (although has come down still somewhat). perhaps the future will be a mix. Say 40 years ago, growth rate is 90% correlated with cost of capital and today maybe it is 50-50, leading to perpetually higher multiiples even if they compress 50%? Btw, high cost of capital businesses have always traded at lower valuation. Even today oil stocks are sub 10x p/e.

Edited November 22, 2022 by scorpioncapital

[Gregmal]

Much of this sort of theory relies on the user making assumptions that they know better than the market, or that they know what the market is thinking in general. Such as "the market is pricing in higher growth rates"...is it? With what certainty can you say that? 

 

Thats the danger there and largely why I just ignore the macro prognostications as they apply to securities analysis. Look no further than WM, again. Pretty sure no one is expecting huge growth there. Maybe people are just paying up for quality? IDK really, but I try to avoid the major underpinnings of a thesis relying upon guesswork. 

[learningfromgiants]

Thanks for the replies and input. I appreciate that it is a pretty blunt tool. 

 

@scorpioncapital  so intangible vs tangible assets, where intangible has lower physical cost and freeing up margin leading to higher ROIC and higher multiples. Is that what you mean? If so, that is a valid point and has certainly been a driving force in the market.  
 

@Gregmalno certainly at all  I am looking at each stock relative to what growth has been priced in and trying to be objective by using CAPM and median Beta. I am not trying to macro prognosticate, but find mispriced micro relative to how companies have been priced in the past. I.e market is pricing in negative growth forever for Company A, but it has priced in between 1-2% for the last 15 years, so it could be undervalued. 
 

In general, I think that I am concerned that the analysts/investors/the market are anchoring on rates being where they have averaged over the last 10 years, not where they have averaged longer term. 
 

Really appreciate the input! 

[LearningMachine]

4 hours ago, learningfromgiants said:

I run watchlists using the rearranged Justified Price to Book Formula to calculate historical, current and consensus implied market earnings growth rates. It is crude, but very interesting. 
 

What I am noticing at the moment is that that as rates in the 10 year have blown out that current prices for many US , especially large cap, names are pricing in abnormally high growth rates, seemingly due to too low cost of capital. This assumes that rates stay flat, which I don’t think is unreasonable given that this was the norm earlier on the 2010s and the 2000s.

 

I am curious whether anyone else is finding that prices in general are still not reflecting the new normal for cost of capital? Many analysts out there are still pricing off of 5 year average multiple ranges, which just seems ludicrous given how the risk free rate has moved. 
 

Any thoughts (especially contrary) would be greatly appreciated! 

 

 

@learningfromgiants, yes, I do find that market is still pricing in abnormally high growth rates for long long times for many companies. 

 

I'm arriving at that differently though. Very simply, a lot of companies are still giving back less than 3% per year to shareholders in terms of dividends plus sustainable buybacks (upto FCF without putting enterprise at mercy of refinancing at high interest rate debt) minus stock-based-compensation.  If you want 15% per year, the rest has to come from growth for long long time. 

 

How many companies really have the longevity and will indeed be able to grow their returns to shareholders at more than 12% per year for long long time at a high certainty?  Not too many.   In case of large caps, you will also end up running into sheer size issues. 

 

Curious how you are calculating implied growth rate? 

Edited November 22, 2022 by LearningMachine

[scorpioncapital]

this article shows that saas stocks are valued somewhat differently than traditional stocks. and there are many of them today. Not just human capital r&d but also the accounting for subscriptions - https://a16z.com/2014/05/13/understanding-saas-why-the-pundits-have-it-wrong/