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Cramer: The Conundrum of Expanding Multiples

NEW YORK (Real Money) --Why are we suddenly willing to pay 18x earnings for General Mills when we were willing to pay only 15x earnings last year and as little as 12x earnings in 2009?

I am talking about the conundrum of multiple expansion and how we are supposed to simultaneously hate that fact and learn to live with it. Unless you are puzzling now over this very issue, I think you are simply not thinking seriously about what's going on in this market.

First, the phenomenon of multiple expansion is not something we should ever be comfortable with. We know that it's totally legitimate to pay more for a stock as its earnings go up. When we decide that a 10% grower like General Mills should get a 15 multiple, then we can match those future earnings streams with that historical multiple and arrive at a price to pay, because in the end, the earnings estimates times the multiple does reveal the stock price.

But how about when we suddenly decide we are going to junk the historical 15x earnings multiple and gravitate, some would save levitate, to 18x earnings? Over the course of just a few months, we have decided not that we should pay up for future growth but that we should pay more for the same growth than we did just a few months ago. That's pure multiple expansion, and we know it should be uncomfortable, because it always feels like you are being like a greater fool when you do. I mean you shouldn't wake up one day and say, "You know what, I am going to pay 19x earnings for General Mills, instead of 18," because implicit in that determination is that someone will come along and pay 19x earnings. If someone doesn't, you should get hurt, as the stock's multiple eventually should revert to the mean.

Or should it?

Editor's Note: This article was originally published on Real Money on March 27. To see Jim Cramer's latest commentary as it's published, sign up for a free trial of Real Money.

That's where we are right now. That's what has to be examined. I think there are two ways to look at this. First, you could ask, what has changed about General Mills? And second, you need to ask, what has changed about the world that we are willing to pay more for the future earnings of the one we always affectionately called "Generous Mills" for its bountiful dividend policy, a title that this stock is indeed most worthy of by any stretch of the imagination?