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I think the question of whether an earnings growth rate of 50% justifies a substantially higher PE can be answered more easily by looking at the expected return on investment compared with other securities. At some point, even investors who don't crunch the numbers can realize intuitively that some other stock will be better. In the past, when dividends were more popular, investors could compare yield. Today, when capital gains are favored, for tax reasons if nothing else, one has to look at return on investment more as the likelihood of building wealth. This broader measure requires not just looking at the PE and the growth rate but at the intrinsic value of the company, including traditional book value, adjusted for the usually unreported assets, such as patents. There is, in my view, no formula that will allow one to calculate how much higher the PE should be in comparison with earnings growth. What I do know, however, is that if one compares a stock like QCOM with AOL, it is clear that QCOM is relatively undervalued and AOL is overvalued, and not just because AOL has a PE ratio about 10 times higher. |
