A top former executive has a warning for corporate America.
The higher the multiple a company is trading in the market, the more it needs to switch things up fast to avoid collapse.
Consider what happened to General Electric, as relayed by its former vice chairman, Bob Wright, in his memoir, "The Wright Stuff," published in March.
GE saw its market value swell to a peak of $600 billion in 2000 — only to then lose a shocking $530 billion of that value by 2009.
The company's net worth had soared as the market gave it a higher and higher price, or multiple, on its earnings power in its heady late 1990s under the tenure of the legendary Jack Welch. GE was trading north of 40 times earnings back then, more than twice a typical stock market multiple.
That high a multiple, even today, is often seen as a kind of "A+" seal of approval on a company's growth prospects.
But that is wrongheaded, warns Wright, who created today's NBCUniversal under then-owners GE and served as GE's vice chairman for much of its downfall period.
"When you are an established company and your stock hits a P/E ratio of over 30, you are likely headed into a bubble," he said.
In fact, "a P/E ratio over 25 for a large established company needs careful examination," said Wright, who now serves on the board of the advocacy group he co-founded with his wife, Autism Speaks.
Cause celebre
Today, a number of S&P 500 companies trade at those lofty levels — and they include some big, established companies alongside the likes of Facebook and Netflix. Clorox, Visa and Estee Lauder are trading north of 25 times forward earnings estimates, according to S&P Capital IQ.
Sure, "that is a time to celebrate," wrote Wright — but it's also "when the CEO should be moving board members out who have been a strong part of the bubble and moving new board members in who can deal with the downside."
That means board members of companies so sought after their market values are soaring would effectively have dismissal as their reward.
"There is no natural churn on boards, which should occur about every seven to eight years, aligning with the average length of time of the CEO," Wright said.
It "would have been helpful if we at GE had encouraged longtime board members to follow Welch out the door," and replaced them with "new board members better prepared for the enormous downside that followed," he added.
This is a chronic problem in business, Wright said — one that's not getting the attention it should.
Stock answers
"Chief executives need strong board members when the stock is on the way up and strong board members when it's on the way down," Wright said, and "they should not be the same people."
"In both cases," he wrote, "you should have board members who are not burdened by the past and are focused on the present to grow the stock and mitigate significant losses."
The trouble is that most companies don't realize their halcyon days will be fleeting, so they aren't opportunistic enough with their high stock price.
"GE should have used its stock for acquisitions while writing off dead, weak or low-yielding assets," said Wright. "We should have dumped or written off assets that weren't producing income and were hurting [return on investment]."
"Instead, we moved from crisis to crisis, with no inclination to examine the big picture and consider whether the problems were in fact bigger and deeper than they appeared."
It is a cycle repeated again and again as America's healthy dynamism continues to generate new corporate giants that topple older ones. The swift rise and fall in the valuation of Apple and Exxon are two more recent examples.
The persistence of this creative destruction continues to surprise not just corporate boardrooms, but also the public.
"Nobody would have thought it was possible for GE's market value to fall from a high of $600 billion to as low as $70 billion at one point," said Wright.
It became — at least, for the time being — "the greatest loss of market capital in business history."