About a year ago I drafted a blog titled ‘Will it ever be the same again?’ where I discussed how investor, cash flows, and growth expectations will impact valuations of privately held companies in the COVID-19 environment. One year later, let’s check how that blog aged over the past year (*spoiler alert* my expectations of what the future held was not even close).
Let us begin with investor expectations. One-year ago, the price to earnings ratio (PE Ratio) for the S&P 500 was approximately 22.22 (this translates to a 4.5 percent capitalization rate). Presently, the PE Ratio is 39.9 or a 2.5 percent capitalization rate. In short, investors are requiring a much lower rate of return in the current market than a year ago. To provide a frame of reference, historically, the PE Ratio for the S&P 500 is approximately 16 or a 6.25 percent capitalization rate.
Moving to cash flows during 2020, for most companies, cash flow has either remained stable or even increased over the past year. It was all the face-to-face industries that struggled during 2020. On the bright side, if a face-to-face company is still operating, then it is expected that the ‘re-opening’ economy will benefit them greatly over the next 12-months.
Lastly, I spoke about the long-term growth expectations over the next few years in my April 2020 blog. Originally, I suggest a decrease in the long-term growth rate of 10 to 20 basis points would be reasonable. One year later, all reported data suggests this was the wrong assessment and furthermore, in today’s operating environment, an increase in the long-term growth rate seems reasonable because of the likely increase in inflation. As a reminder, the long-term growth rate is a nominal rate (real rate of growth + the inflation rate).
So, to sum up, the decrease in investor expectations has put upward pressure on asset prices, the increase in cash flow has increased asset prices, and the increase in the long-term growth rate due to inflation has increased asset prices. I cannot say I saw this coming a year ago.
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Michael R. Metzler, Director, CPA, ABV, CMA, CGMA, ASA