Markets finished the week lower as investors attempted to "price in" the potential for as many as fourLast week, we discussed what this means for those investors utilizing discounted cash flow models — arguably the most diligent way to determine a company's intrinsic value — so this week, let's take a look at valuation multiples, which are also used to determine the "terminal value" in a discounted cash flow model.
In general investors looking more near- to- mid-term will look at a company's price to earnings multiple, the multiple being placed on a company's near-term earnings. For example, is expected to earn $5.76 per share this fiscal year — so at a price of $172, shares trade at just below 30x earnings. However, similar to reassessing the discount rate in a DCF model when rates rise, investors must also reassess valuation multiples. That's exactly what we saw play out this week, especially in the high fliers and particularly in the names that don't even have earnings and therefore trade on sales-based multiples.
This is what you hear being referred to when investors mention "multiple contraction," when interest rates go up , investors value companies using a lower valuation multiple. This is also crucial to understand because when a re-rating occurs, we often cannot look to recent highs, especially in the high fliers, as the environment has changed and the market may simply be unwilling to look back at the multiples applied in the lower rate environment.
Lastly, one more term you will often hear in this market is GARP or growth at a reasonable price. This is the term used for those names that strike a nice blend of growth and value and may therefore be able to hold up better when the selling hits the high fliers, while still providing exposure to underlying business growth.
My take from the week is how soooo underrated Cathie Wood and her ARK Fund is. She is truly awesome, and her fund is only a tiny bit off. This is a real buying opportunity. I hope CNBC and its on air talent can pump her up, and her fund, once again. That would be awesome!
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