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There is a particular kind of frustration that value investors know well. You pull up the financials of Hermès or Ferrari, you see the price to earnings ratio, and you close the tab. Forty times earnings. Fifty. Sometimes more. The numbers look like a typo. Surely the market has lost its mind. Surely this will correct.
It never does.
Year after year, these companies trade at valuations that would make Benjamin Graham turn in his grave. And year after year, the people who waited for the dip got left behind. This is not a story about irrational markets. It is a story about what happens when a business operates under a completely different set of economic rules than the ones we learned in school.
The Ordinary Logic of Valuation
Let us start with the basics. A price to earnings ratio tells you how much investors are willing to pay for each dollar of profit a company generates. A P/E of 15 means the market values a company at fifteen times its annual earnings. The higher the number, the more optimistic the market is about the future. The lower the number, the more skeptical.
Most companies live in a range. Banks trade at modest multiples because their growth is tied to the economy. Tech companies trade higher because the market believes they will scale. Industrial firms sit somewhere in the middle.
Then there are companies like Hermès, which has spent the better part of two decades trading at a premium that most analysts would call absurd for any other business on the planet. Ferrari tells a similar story. These are not hypergrowth startups burning cash to capture market share. They are mature businesses selling physical goods. Handbags and sports cars. And yet the market prices them as though they have discovered something that no one else has access to.
The uncomfortable truth is that it has. The market is not wrong. We are just using the wrong framework.
Scarcity as a Business Model
The first thing to understand about Hermès and Ferrari is that they do not operate like normal businesses. A normal business wants to sell as much as it can. More customers, more revenue, more growth. The entire machinery of modern capitalism is built on the assumption that a company’s job is to maximize output.
Hermès and Ferrari reject this premise entirely.
Ferrari produces roughly 14,000 cars per year. It could produce more. It has the capital, the engineering talent, and certainly the demand. But it does not. The waiting list for certain models stretches years into the future. This is not a manufacturing bottleneck. It is a deliberate choice. Ferrari understands something that most businesses never grasp: the moment supply meets demand, the spell breaks.
Hermès operates on the same principle. The Birkin bag, perhaps the most famous luxury product in existence, cannot simply be purchased. You do not walk into a store and buy one. You build a relationship with the brand. You spend. You wait. You are eventually offered the opportunity to buy one, if you are deemed worthy. This is not a sales process. It is a courtship ritual that would feel familiar to anyone who has studied anthropology.
And this is where the valuation starts to make sense. When a company deliberately constrains its own supply, it creates a kind of economic moat that is almost impossible to replicate. You cannot disrupt artificial scarcity with a better algorithm or a cheaper supply chain. The scarcity is the product.
The Veblen Exception
In economics, there is a concept called a Veblen good. Named after the sociologist Thorstein Veblen, it describes a product for which demand actually increases as the price goes up. This violates one of the most fundamental assumptions in economics: that higher prices reduce demand.
Most products follow the standard curve. Raise the price of bread and people buy less bread. Raise the price of a Birkin bag and somehow the waiting list gets longer. This is not because the leather is worth that much more. It is because the price itself is part of the value proposition. The expense is not an obstacle to the purchase. It is the reason for the purchase.
This creates a feedback loop that is almost perverse in its elegance. Higher prices lead to more exclusivity. More exclusivity leads to more desirability. More desirability supports even higher prices. The company is not fighting against the laws of supply and demand. It is operating in a parallel universe where those laws run in reverse.
For an investor trying to value these businesses using conventional metrics, this is maddening. Traditional valuation assumes that margins will compress, that competition will emerge, that pricing power will fade. For most businesses, this is true. For Veblen goods, the opposite happens. Pricing power compounds.
The Moat That Money Cannot Buy
Warren Buffett famously talks about economic moats. The idea is simple: a great business needs a durable competitive advantage that protects it from competitors. These moats come in different forms. Network effects. Switching costs. Patents. Scale advantages.
Hermès and Ferrari have something different. Their moat is time.
Hermès was founded in 1837. It started as a harness workshop serving European noblemen. Ferrari’s story begins with Enzo Ferrari racing cars in the 1920s. These are not brands that can be manufactured in a boardroom. You cannot raise a billion dollars in venture capital and create a heritage that spans centuries. You cannot hire a branding agency to fabricate the kind of mystique that comes from decades of carefully cultivated exclusivity.
This is what makes luxury conglomerates so interesting from an investment perspective. LVMH, Kering, and Richemont have spent billions acquiring brands precisely because they understand that authentic heritage is a finite resource. There are only so many houses with genuine history. Once they are all owned, the supply of real luxury brands is effectively frozen.
Think of it like real estate in Manhattan. They are not making more of it. The scarcity of the asset itself is what justifies the price. The same logic applies to a brand like Hermès. There is exactly one Hermès. There will never be another. And every year that passes adds another layer to the moat.
Why the Multiple Never Contracts
Now let us return to the valuation question. Why does the P/E ratio never come down?
The conventional answer would involve growth projections and discount rates and terminal values. But those tools miss the deeper point. The multiple stays elevated because the risks that normally justify a lower valuation simply do not apply to these businesses in the same way.
Consider the typical threats that drag down a company’s valuation. Commodity competition. Margin pressure. Customer churn. Disruption from new entrants. Cyclical demand.
Hermès sells products where the brand name accounts for the vast majority of the value. You are not paying for the leather. You are paying for the name on the leather. This means that raw material costs are almost irrelevant to the pricing equation. When cotton prices spike, H&M suffers. When leather prices spike, Hermès does not even notice.
Customer churn barely exists. The people who buy Hermès are not comparing prices. They are not downloading an app to find a cheaper alternative. The entire point is that there is no alternative. Brand loyalty in true luxury is not a marketing metric. It is closer to a religious conviction.
And cyclical demand? This is where it gets genuinely counterintuitive. Luxury goods at this level are remarkably resilient during economic downturns. The customers are wealthy enough that a recession does not change their purchasing behavior. During the 2008 financial crisis, Hermès barely flinched. During the pandemic, Ferrari’s order book actually grew. The customer base is insulated from the economic forces that punish almost every other consumer business.
So when you look at a P/E of 50 or 60 and think it must be overvalued, ask yourself what would cause it to contract. What scenario brings Hermès back to earth? The answer, most of the time, is nothing short of the company destroying its own brand. And the people running these businesses have spent their entire careers making sure that never happens.
The Art World Parallel
There is a useful analogy outside of finance that helps explain what is going on here. Consider the art market.
A painting by Basquiat sells for $110 million. The canvas and paint cost perhaps $50. The labor took days, not years. By any rational measure of inputs and outputs, the price is insane. And yet no one in the art world finds this surprising. The value of a painting has almost nothing to do with its physical properties. It has everything to do with provenance, rarity, cultural significance, and the story attached to the object.
Hermès and Ferrari operate in the same conceptual space. A Birkin bag is not a bag in the way that a Toyota is a car. It is a cultural artifact. A Ferrari is not transportation. It is a statement, a membership card, an identity. The physical product is almost incidental to the value being exchanged.
This is why traditional valuation frameworks struggle with these businesses. The frameworks were designed for companies that produce commodity goods or scalable services. They assume that value is created through efficiency, innovation, or growth. Hermès creates value through restraint, heritage, and the careful management of desire. These are not concepts that fit neatly into a discounted cash flow model.
The Trap of Waiting for Cheap
Every year, some analyst publishes a note arguing that Hermès is overvalued. The math is always impeccable. The growth rate does not justify the multiple. The earnings yield is paltry compared to alternatives. The conclusion is always the same: wait for a pullback.
This is the value trap in reverse. Normally, a value trap is a cheap stock that stays cheap because the business is deteriorating. With Hermès and Ferrari, the trap works the other way. The stock never gets cheap because the business never deteriorates. The investors who wait for a reasonable entry point end up watching the stock compound for a decade from the sidelines.
There is a psychological dimension to this as well. Investors who pride themselves on discipline and rationality have a hard time paying 55 times earnings for a handbag company. It offends their sense of how markets should work. But markets do not care about how they should work. They care about what buyers are willing to pay. And buyers have been willing to pay these multiples for a very long time.
The lesson here is not that valuation does not matter. It always matters. The lesson is that the fair valuation for a business depends on the durability of its advantages. And when those advantages are essentially permanent, the fair multiple is much higher than our instincts suggest.
The Fragility Beneath the Surface
It would be dishonest to pretend there are no risks. There are. They are just different from the risks that threaten ordinary companies.
The greatest threat to Hermès or Ferrari is not competition. It is the brand itself. Luxury at this level is a carefully maintained illusion, and illusions can shatter. If Hermès overproduces, the scarcity narrative collapses. If Ferrari licenses its name too aggressively, the exclusivity fades. If a creative director makes a series of bad decisions, the cultural relevance erodes.
These are not risks that show up in financial statements. You will not find them in the quarterly earnings report. They are qualitative, subtle, and almost impossible to model. But they are real. The history of luxury is littered with brands that overreached. Pierre Cardin licensed his name so aggressively in the 1980s that it ended up on sardine cans. The brand never recovered its former prestige. Burberry spent years clawing back its image after it became associated with a customer base it had not intended to attract.
The management teams at Hermès and Ferrari understand this fragility intimately. It is why they resist the Wall Street pressure to grow faster, produce more, and expand into new categories. Every quarter, some analyst asks why Ferrari does not make more cars. The answer is always the same polite refusal. They know that the moment they give in, they become just another automaker with a nice logo.
What the Multiple Really Measures
In the end, the P/E ratio of Hermès or Ferrari is not measuring what we think it is measuring. It is not simply a reflection of expected earnings growth. It is the market’s way of pricing something that does not have a clean financial label: the probability that a business can maintain an almost supernatural hold on human desire for decades to come.
That sounds abstract. But the cash flows are very real. The margins are extraordinary. The returns on capital are among the highest of any business in any industry. The growth, while not explosive, is remarkably consistent. These are phenomenal businesses by every quantitative measure. The premium valuation is not a fantasy. It is a recognition that the qualitative advantages are so powerful that the quantitative results are almost guaranteed to follow.
So no, Hermès and Ferrari will probably never look cheap. Not because the market is irrational, but because what they sell is not really a product. It is a feeling, a status, a story that people have been willing to pay for since long before stock markets existed. The P/E ratio is just the number we use to argue about it.
And the number, for once, might be telling us exactly what it should.
