Saturday, July 21, 2012

The trouble with rich valuations

A wonderful example of what happens to the market value of a company if it has been richly valued and manages to do good business, here.
Using the Chipotle example (in the link), a stock that trades at a 45x P/E implies an yield of 2.22%. If the company manages to even double its earnings next year, the P/E without discounting would drop to 22.5x and implies an yield of 4.44%.
To better understand this, a business growth of ~100% increases my earnings yield (as the business owner) to only 4.44%. High multiples can be justified for companies which (acc. to the investor) show immense potential of showing rapid growth; but Chipotle was a USD 19 Bn company - so, what are the odds of the company showing stupendous growth, such that it exceeds market participants' outrageous expectations?
One does not get returns just because one wants them.

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