As an IOI reader, you must know that we have no love lost for multiples-based analyses. We believe they can be terribly misleading as a sole rationale for investment. On his blog in August, Aswath Damodaran, the valuation guru at NYU Stern School of Business, has penned this lovely piece on one of the favorite multiples tools of “value investors”, the Cyclically Adjusted Price Earnings analysis know more commonly as “the CAPE”.
Robert Shiller developed and has popularized CAPE as a tool to evaluate the relative value of an equity or equity index. It has been used to some degree as an information source for macro level perspective on the equity markets.
Damodaran in academic style looks hard at the predictive nature of the CAPE (on a market level basis) and also makes the excellent point that investment is relative and not absolute meaning that you evaluate investments not in a vacuum, but against a set of contemporaneous alternatives. That’s just a crucial point. You may have to hold your nose, but a skunk is still the best choice for a pet when compared to a crocodile or full grown Bengal tiger.
On top, we LOVE cash flow at IOI. As owners of companies, we care terribly much about getting more actual money back than we started with. Damodaran addresses the market’s kryptonite by looking carefully at where we are in the cash flow generation cycle. This alone is worth the time to read this piece.
This is a thorough, thought-provoking piece that we can all benefit from reading.
In the meantime, Invest Intelligently.