Tuesday, November 29, 2005

Valuation Matters

"As Ben Graham said, 'In the short run, the market is a voting machine, but in the long run, it's a weighing machine.' Sooner or later, the amount of cash a business can disgorge will determine its value in the market."

"Think about a company with a market cap of $500 billion. To justify paying this price, you would have to earn $50 billion every year until perpetuity, assuming a 10% discount rate. And if the business doesn't begin this payout for a year, the figure rises to $55 billion annually, and if you wait three years, $66.5 billion. Think about how many businesses today earn $50 billion, or $40 billion, or $30 billion. It would require a rather extraordinary change in profitability to justify that price."

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