Lesson 8 of 12 · 3 min · Valuation
What is already in the price
Every price makes a quiet bet on the future.
Here is a rough shortcut. What you earn from a stock over time is about its earnings yield plus the growth of its profits.
Lemon Co’s earnings yield is 5%, the flip side of its P/E of 20. If you want about 9% a year, its profits need to grow about 4% a year.
Now compare a hot stock with a P/E of 60. Its earnings yield is under 2%. To reach the same 9%, profits have to grow more than 7% a year, for many years.
So the real question is never "is this a good company?" It is "is this company better than the price already assumes?"
For Lemon Co, 4% growth looks reachable if it keeps opening stands. That is a belief you can check against its history, not a guess.
Quick question
Stock X has a P/E of 50. What does its price quietly assume?
- That profits stay flat
- That profits grow fast for a long time
- Nothing, P/E says nothing about growth
Show the answer
That profits grow fast for a long time
At a P/E of 50 the earnings yield is only 2%. Only fast, lasting growth makes that price pay off.
Keep this one
Ask what the price already expects.
Where this comes from
The shortcut return ≈ earnings yield + growth is a simplification of the dividend growth model. It works best for steady companies. Lemon Co is invented for teaching.