From Money, May, 1997
[discussing Factors to look for when picking stocks]
--A price/earnings multiple that does not exceed the growth rate by more than 25%.
Sometimes investors' expectations (as reflected in the stock's price) can be so high that even the sturdiest growth machine is bound to disappoint--with ugly consequences for shareholders. You can reduce that risk by comparing your stock's P/E based on its estimated next 12 months' earnings with its projected five-year earnings growth rate. If the P/E is more than 25% higher than the growth rate--for example, the P/E is 23 and the company is expected to grow 15% a year--the stock is in dangerous territory. Ideally, you would like to find a fast-growing company trading at a P/E less than its growth rate.
That's why Robert Natale, director of equity research at S&P, has his eye on 3Com (COMS; Nasdaq, $ 33), the Santa Clara, Calif. networking company, which recently agreed to acquire modem manufacturer U.S. Robotics. Recently, 3Com was trading at a P/E of 15, partly because of a temporary earnings shortfall.
But Natale points out that 3Com's profits are already back on track, rising 18% in the past quarter. He figures that the long-term annual profit growth rate will be on the order of 30% to 40%, thanks to continued strong demand for the network- ing products. Natale pegs the stock price at $ 50 in the next six to 12 months for a 51.5% gain. |
