Article at a glance:

All P/Es are not created equal

A high P/E multiple is not driven by growth alone. Managers who understand how growth and returns on capital combine to shape a company's multiple can use that knowledge to drive higher growth and make better investment decisions. This article presents a method for determining how much of a company's current value can be attributed to expected growth and to returns on capital, respectively, by factoring in the impact of high levels of returns on invested capital and disaggregating value into three parts—current performance, return premiums, and value from growth.

The take-away

Managers shouldn't focus so intently on meeting a company's growth objectives as to ignore an investment's or acquisition's returns on capital. When they are low, no amount of growth will lead to a high P/E, because such growth does not create shareholder value.