I wonder why Orient Express commands higher multiples than safer peers in the current market.

Orient Express has been spending heavily over the last few years to grow its business. In 2007, the company generated $52 million in cash flow from operating activity, yet it spent $121 million investing in new capital. In each of the last three years, the company has had to raise as much as $135 million by issuing new debt, issuing more shares or tapping into working capital facilities. If access to financing is curtailed or becomes more expensive, as is likely, the growth efforts may have to take a back seat until the economy mends. That would likely result in additional steep cuts to estimates.

Starwood, meanwhile, can plug along with its expansion plans without needing access to outside financing. Its free cash flow has been positive in each of the last three years, and it amounted to $511 million in 2007. The approximate 5% free cash flow yield is not the best I’ve seen, but it is nearly twice the current yield on five-year Treasuries. More important, it provides a cushion against any operational slowdown that might rear its head.

With both companies expected to grow their earnings in the mid-20% range next year, I can’t see paying a higher multiple for the riskier stock. If Orient Express were to trade at Starwood’s P/E multiple on 2009 earnings, it would fall by another 33%, to $30. Meanwhile, I believe Starwood would be justified in maintaining its current free cash flow yield. If free cash flow grows in line with expected earnings, it could rise 23% to $67.50.

Disclosure: At time of publication, William Trent has no positions in the companies mentioned.