'multiple compression as a headwind'?
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So you are inferring investor psychology? Simplify or explain further? This is an interesting concept if i'm understanding.


No, not psychology.

It's just based on the observation that high P/E ratios never last forever, for very rational reasons. Pretty much any firm will trade at a multiple in the teens on owner earnings sooner or later, since any multiple above that is prepaying for unusually high future growth rates. No firm has that kind of growth forever, so the growth rate fades and the premium multiples fade. On very rare occasions it's a really long time before the multiple sags, but it's generally inevitable. This means a big headwind: the price can be falling even if the earnings are still growing. It's a one time hit which ends when the multiples get down to a "normal" range, which I surmise Alphabet seems to be entering now. At 19 times recent earnings, the price does not seem to include any assumption of unusually high future growth rates.

Thus my comment: buyers today are not prepaying for unusually high future growth--(solid, but nothing special)--so there is no "extra high" multiple, so there is no price drop coming because the multiples are destined to fall.

Contrast that with (say) Microsoft at 30 times earnings today. People are prepaying for at least another 50-75% in growth in earnings power per share that hasn't happened yet. They might be right--let's say they are. That means that even if those earnings do arrive, the price would be flat from now till then unless at the end of that process the growth even further into the future is still perceived to be unusually good and therefore deserving of a multiple over 20 for another finite time period.

It's certainly true that high future growth rates are worth a huge premium. P/E ratios *should* be higher. But it's also true that statistically the average investor prepays a little bit too much for a rosy future. In the last 39 years, US stocks purchased at P/E over 30 underperformed those bought at P/E under 30 by 4.76%/year.

Jim