We can think of valuing a company in two steps. First, forecast the future earnings of the company. Next, decide how much to pay for those future ea

The Decade of Greed - by Arnold Kling - In My Tribe

submited by

Style Pass

2024-12-30 23:00:03

We can think of valuing a company in two steps. First, forecast the future earnings of the company. Next, decide how much to pay for those future earnings. This is true conceptually, but in practice it is difficult to know which factor is at work, because we do not know what investors expect for earnings in the indefinite future. We can only look at the ratio of the stock price to earnings today, or the ratio of price to earnings projected for next year.

Since 1980, all of the major stock price indexes have been on a strong upward trajectory. Some of that has come from higher earnings. But most of it comes from either an increase in the estimate of future earnings growth or, more likely, a willingness of investors to pay more for a given level of expected future earnings.

I would argue that this began in the 1980s, the “decade of greed.” I have been re-reading Barbarians at the Gate, a 1989 best-seller by journalists Bryan Burrough and John Helyar about the takeover fight for RJR Nabisco. 1 This was the climactic leveraged buyout of the period. In the book’s epilogue, the authors write,