Evaluating Valuations
U.S. equity price-to-earnings (P/E) multiples are higher than their historical average. However, an examination of the changing nature of business models suggests that valuations may be more attractive than they appear.

Chart for AOM​​

  • P/E multiples for U.S. equities are higher than they have been historically but free cash flow multiples are actually lower than they have been historically. How is this possible?

  • As the economy has changed over the years so too have business models. New, knowledge-based businesses are able to convert more of their net income to cash because they are less capital intensive and much of their “investment” is recorded on the income statement (e.g., R&D) rather than the cash flow statement (e.g., capital expenditures).

  • The software industry, for example, has free cash flow margins that are several hundred basis points higher than its net income margins. By contrast the machinery industry has much lower free cash flow margins as compared to its net income margins.

  • Investors should be careful not to simply compare valuation multiples across history given the changing face of the U.S. economy. Stronger free cash flow margins (along with lower interest rates) may justify higher P/Es and indicate stocks are more attractive than P/Es suggest.


The views expressed are the views of Fred Alger Management, Inc. as of July 2019. These views are subject to change at any time and they do not guarantee the future performance of the markets, any security or any funds managed by Fred Alger Management, Inc. These views are not meant to provide investment advice and should not be considered a recommendation to purchase or sell securities.​

This material must be accompanied by the most recent fund fact sheet(s) if used in connection with the sale of mutual fund shares.

Risk Disclosure: ​Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Many technology companies have limited operating histories and prices of these companies’ securities have historically been more volatile than other securities, especially over the short term. Technology companies may also face increased competition, government regulation, and risk of obsolescence due to progress in technological developments.​​

Fred Alger & Company, Incorporated 360 Park Avenue South, New York, NY 10010 / www.alger.com

800.305.8547 (Retail) / 212.806.8869 (Institutional) ​