-----Original Message----- From: owner-lbo-talk at lists.panix.com [mailto:owner-lbo-talk at lists.panix.com]On Behalf Of Michael Pollak Sent: Wednesday, April 05, 2000 10:55 AM To: lbo-talk at lists.panix.com Subject: Re: executive options
On Tue Apr 04 2000, Doug Henwood wrote:
> You could buy on any assumptions you wanted. Conventional valuation
> methods are based on assumptions about growth, interest rates, and
> volatility. A 7% profit growth rate is still faster than GDP trend
> growth, so you're betting on the profit share of GDP continuing to
> grow. If you expect profits to grow in line with GDP, then you'd be
> paying 30-40 times earnings for 3-4% returns, which would suck,
But if stock market returns are proportional to profits, and profits can
only grow over the long run at the same rate as GDP growth (because if
they outsripped it consistently, eventually they would outstrip GDP), that
seems to mean it's impossible for the stock market to generate an
historical average return that's greater than GDP growth over the long
run. But hasn't it done just that, by historically returning 6%? Under
this assumption, shouldn't profits have eaten the whole economy long ago?
Michael
>>>>>
Depends on how you define your terms.
Profits should track the capital stock and a more-or-less fixed profit share of GDP means profits track GDP. (Though the profit share of GDP has been increasing.) Given this, the rate of return on capital can be anything, since the equality of growth of profits, GDP, and capital says nothing about the ratio of profits to capital stock.
In a rational but simple world, the returns to stock ownership ought to track the ratio of profits to capital stock, or the rate of return on capital. Putting aside all the reasons this does not happen, the ROR could exceed GDP growth indefinitely without profits eating up GDP.
There is some macro theorem on why the real rate of return to capital should equate to the rate rate of growth of GDP. But I've forgotten it. It's been a while since I did my comps.
mbs