Mind The Multiple: What P/E Ratios Reveal About Future Growth

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I recently met with a team that’s exploring how to reinvent their company’s commercialization strategy. We spent an hour talking about where the company might grow, how it could play to its strengths, and what changes in artificial intelligence might mean for the business. The conversation ranged pretty widely, as these conversations tend to do. At one point, we were talking about new customer needs. A little later, we were discussing capabilities the company might need to build. Then someone on the team, who we’ll call Lucy, asked a deceptively simple question: “What metrics should we use to measure whether our innovation efforts are successful?”

There are plenty of reasonable answers to Lucy’s question. Incremental revenue. Margins. Customer adoption. Market share. Maybe even the price that the company stock is trading at. These are numbers that most large companies have readily available. Most managers can tell you roughly how much revenue their business generated last year. A lot of them can tell you where the company’s stock is trading, especially if some portion of their compensation depends on it. They probably know whether margins are improving, whether the company hit its numbers last quarter, and what management has promised for the year ahead. But there’s one indicator that’s often overlooked by managers. And that’s a company’s earnings multiple.

In a lot of companies, relatively few people can tell you what earnings multiple their company is trading at. That’s a problem, because a company’s earnings multiple may be one of the clearest outcomes of innovation effectiveness. And for a publicly traded company, it’s a great signal for how much of a future people think it has.

What the Market Believes

For those of us who skipped business school, an earnings multiple is usually expressed as a company’s price-to-earnings ratio, or P/E. At a simple level, you can think about it as the company’s market value divided by its earnings. The S&P 500 currently trades at roughly 20 times forward earnings. “Forward earnings” are simply what analysts expect companies to earn over the next twelve months. So investors are effectively paying around $20 for every dollar of profit they expect the companies in the S&P 500 to generate over the coming year.

Of course, there are plenty of reasons why one company deserves a different multiple from another. Interest rates matter. Risk matters. Some industries require more capital than others. A business with recurring revenues gets viewed differently from one whose profits disappear every time the economy turns down. Nobody should look at a P/E ratio and pretend it explains everything about a company’s value.

Still, the earnings multiple captures something strategically important. It reflects, however imperfectly, what investors believe about the earnings that haven’t happened yet. If people think a company can keep growing, enter new markets, develop new businesses, and generate much larger profits over time, they’ll generally pay more for its earnings today. If they see a mature business with fewer places left to grow, they’ll generally pay less.

To be sure, the market can get those judgments spectacularly wrong. Investors fall in love with stories that don’t come true. (Theranos, anyone?) Bubbles happen. Great companies get overlooked while ridiculous companies become briefly fashionable. An earnings multiple isn’t some divine assessment of corporate worth, but it is a kind of consensus belief about how much of a future a company has.

Consider Ford and Tesla. Ford is an enormous enterprise. It sells millions of vehicles. It employs nearly 168,000 people worldwide. And it operates manufacturing plants around the world. Ford generates $187 billion in revenue, which is nearly twice Tesla’s $95 billion. But Ford’s stock trades at roughly eight times forward earnings. Tesla trades at something closer to 190 times.

You don’t pay 190 times earnings for a car company because you think it’s going to sell a few more cars next year. Embedded in Tesla’s valuation are expectations about autonomous driving, energy storage, robotics, artificial intelligence, and other businesses that may still be taking shape. Maybe all of those expectations are reasonable. Maybe half of them are hype—it’s hard to tell. What matters is that Ford is the bigger business and Tesla is the more valuable one. The gap between those two numbers says a great deal about what people imagine comes next.

You can see a less extreme version of the same phenomenon with McDonald’s and Chipotle. McDonald’s is undoubtedly one of the greatest restaurant businesses ever created. It has a global brand, thousands of locations, enormous purchasing power, and a franchise model that produces remarkably consistent profits. Its stock currently trades at around 19 times forward earnings. Chipotle trades closer to 28 times.

Chipotle doesn’t have anything approaching McDonald’s scale. What it has is more perceived running room. Investors can imagine thousands of additional restaurants, more international markets, and years of growth before the business begins to look truly mature. McDonald’s is being rewarded for certainty. Chipotle is being rewarded for possibility.

Of course, that possibility isn’t permanent. Chipotle’s multiple has already fallen substantially from where it was a couple of years ago as investors have become less exuberant about its growth. The company didn’t suddenly become terrible. People simply became a little less willing to pay for a future that hadn’t happened yet. It turns out that a high earnings multiple isn’t a trophy a company wins and keeps. It moves as people change their minds about how much future they’re willing to believe in. And there are even more astounding examples than cars and burgers.

The Insanity of SpaceX

SpaceX is currently worth on the order of $2 trillion. And yet, we can’t even calculate a price to earnings ratio because there aren’t any earnings to multiply. Last year, the company generated about $18.7 billion in revenue and still lost money. Investors are effectively valuing the business at more than 100 times sales, profits be damned.

That’s kind of insane. Or incredibly future-focused. After all, nobody is paying $2 trillion for the profits that SpaceX produces today. Investors are paying for what they think the company might become. They can imagine Starlink providing connectivity around the world. They can see Starship opening up entirely new businesses in space. There are possibilities in defense, communications, infrastructure, and other markets that may not meaningfully exist yet.

Importantly, SpaceX has also given people reasons to take those possibilities seriously. It launches rockets, and those rockets land themselves. Starlink has millions of customers. Governments buy SpaceX services. SpaceX businesses that sounded outlandish a decade ago now exist and generate real revenue. SpaceX has spent years creating an expansive story about its future while accumulating enough evidence to suggest that its story might actually be true.

There’s a lesson in that for companies whose ambitions are considerably more earthbound: improving your share price isn’t just about winning in the Now. It’s about showing what’s Next and proving it’s real.

Showing What’s Next

The biggest contribution that growth and innovation work can make isn’t simply generating sales today. It can improve the forward outlook of the company. That happens when people begin to believe that the business has more places to go, more things it can become, and more sources of earnings that haven’t yet shown up in the current P&L.

A growth program has two jobs. It needs to produce a credible story about where future growth will come from and evidence that the story might actually be true. Most large companies are perfectly capable of producing the story. Investor presentations are filled with attractive markets, emerging technologies, and new sources of growth. Management teams talk about platforms, adjacencies, ecosystems, and transformational opportunities. Somewhere there’s usually an arrow pointing toward a large number in the upper right-hand corner of a slide.

Eventually, though, you need to prove it. Someone has to show that the company can actually do something. Maybe a new product starts gaining unexpected traction. An experiment reveals that customers are willing to behave differently than anyone expected. A research team proves that a technology works. A small acquisition brings in a capability the company never had before. None of those things has to be a fait accompli. Early evidence is usually messy and the revenue might still be tiny. The team may have to change direction three times before finding something that works. But you need to show enough activity to suggest there’s a there there.

That’s why experimentation matters so much. A portfolio of small bets gives a company more chances to discover where real growth might come from. It also produces proof points that can make an emerging future more credible. The new business doesn’t need to move the company’s earnings today. It needs to begin changing what people believe could happen tomorrow.

SpaceX didn’t become worth $2 trillion overnight. It spent years turning seemingly ridiculous ideas into things people could actually see working. The story got bigger as the evidence accumulated.

Digging Through the Couch Cushions

That’s a skill that takes practice. And it’s something that many large companies have forgotten how to do. Many scaled businesses are organized to improve today’s earnings, not to create a more compelling future. They have productivity goals, margin targets, and teams devoted to finding efficiencies. When a company needs to improve performance by the end of the year, there are usually plenty of smart people who can find expenses to cut and operations to streamline. That work matters. But it doesn’t help you show what’s Next.

Those questions are much harder to manage inside a large organization because the long term is harder to prove. A cost reduction can be modeled in a spreadsheet and delivered by the end of the year. An experiment may not pay off for five years. And when a company is under pressure, resources naturally migrate toward the things that can be measured most confidently.

As a result, a company can get remarkably good at squeezing more earnings out of its existing business while giving everyone fewer reasons to believe there’s another act ahead. The current business gets leaner. Margins improve. And somewhere along the way, the future starts to look a little smaller.

That’s not to say that we shouldn’t drive for efficiency. We just have to rightsize our expectations on what it will get us. Trying to create long-term value by improving efficiency is a little like improving your family finances by digging through your couch cushions for spare change. There are probably a few quarters down there. But you’re never going to put your kids through college with what you find.

What Are You Trying to Prove?

Which brings us back to Lucy. Her question points to an important distinction: most innovation and growth work shouldn’t be measured on whether it streamlines the current business. Revenue and margin will matter. So will all the near-term indicators that show whether an idea is gaining traction. Lucy and her team shouldn’t put “P/E multiple” on their scorecard; the market controls that number. But she may have pointed us to a more interesting way to think about the work we do: is what we’re doing giving anyone more reason to believe this company has a future?

That’s what future-focused leaders pay attention to. They make room for initiatives whose job it is to make the next five years more believable. That means letting small experiments stay small long enough to learn something. It means protecting strange new ideas before the economics look impressive. And it means asking teams to show what they’re learning before demanding that they show what they’re earning.

Maybe that’s why it’s so important to mind the multiple. It forces teams to ask a question that all those beautifully precise operating metrics can hide: what are we doing right now that gives anyone a reason to believe there’s more to come? If the answer is hard to find, that’s worth knowing. The future doesn’t show up by magic. Someone has to start making it real.