Conclusions Of The Firm-Foundation Theory*

1. P/E multiples are higher for stocks for which high growth is anticipated – for “fast growers”. This is because “share prices must reflect differences in growth prospects if any sense is to be made of market valuations. Also, the probable length of the growth phase is very important. If one company expects to enjoy a rapid 20% growth rate for ten years, and another growth company expects to sustain the same rate for only five years, the former company is, other things being equal, more valuable to the investor than the latter.” – Burton G. Malkiel, A Random Walk Down Wall Street, 109.

2. The market should be willing to pay a modest premium above the growth rate for a fast grower. For example, Microsoft sold at 36 times earnings when the street expected 20% growth for the company in the early 2000’s. Some might regard this as an overvaluation and disregard the stock. This is such a time as when to “get out”.

3. Stocks are valued on (future) expectations – not facts. These expectations are based on analyst estimates and the estimates and favorability of the market towards the stock. However, the future (earnings) is not easily estimated, even by market professionals.

*Burton G. Malkiel, "A Random Walk Down Wall Street"