Dan,
this PE/growth formula is one of the most misunderstood indicator that is also very commonly used. It took me a while to figure out because I see these "over valued" stocks, defined as having PE higher than growth rate, keep going up and above my target buy price.
If you are in Southern California, there is a guy on the radio named Jerry Klein who misinforms his listeners everyday with his "secret" formula. I know. I was one of the misinformed. He always opined that when a stock's PE is higher than the growth rate, it is over valued. He had bad mouthed QC for years because he said QC refused to do a presentation at one of his weekend sales pitches.
Let us use 3 stocks in a perfect world as an example. One stock has a consistent growth rate of 10%, one grows at 20% and the last at 30%. They are trading at 10, 20 and 30 PE respectively. The PE/growth model would lead you to believe that all 3 are fairly valued and therefore equal in investment value.
All you have to do is punch in a 6 (or any number of) year projection using excel or any spreadsheet and you will see the fallacy. The stock with the 30% growth rate clearly will out perform. The 10% stock will return 61%, the 20% stock will return 148% and the 30% stock will return 271%. If you are conned into thinking the 3 stocks are the same, then you would end up buying something like IBM, thinking that it will have the same potential as QCOM 3-5 years from now.
The conclusion is if you can find a true 30% grower trading at 30 PE, buy it. In reality, I think you will find very very few stocks that have a 30%+ growth rate for many years. Look at the big winners like MSFT, CSCO, INTC, etc, none of them are likely to grow at a 30+% rate for the next five years. They are all rewarded for their performance of yesteryears. QCOM, on the other hand, is just entering its real growth phase.
As for analysts opinions, I just started reading "The Crisis of Global Capitalism" by Soros. He explained it in the first chapter. These analysts have an active function in trying to influence the outcome of events that have yet to occur. They are really not lying nor are they telling the truth. By their participation (recommendations), they are actively trying to change the investment behavior of tomorrow.
What a rant? I must have had some of Maurice's sherry.
Ramsey |
