To: shuebert who wrote (23686 ) 4/27/2000 1:49:00 AM From: Seeker of Truth Read Replies (2) | Respond to
I'm not up on evaluation either, but here's a possible ladder, short as it may be, to get closer up there. Suppose a stock is growing(the book value, the sales and the profits) at 50% a year. What is the right P/E? You can see the error at once from the silliness of the question. This number 50% is either the last two known years or last year's known figure compared with this year's unknown figure. But we don't invest for one year and then the world is finished, curtain falls. What we are interested in is the entire future. Some 50% a year stocks are simply stronger than others. So for one stock we might estimate growth rates of 50%, then 30% then 15%. Another stock might grow at the rate of 50%,then 45%,then 40% etc. If we think this is a reasonable guess as to the future then we should pay more for the latter stock than for the former. Some companies jumped into a growth area early but barriers to entry are low so much competition can be expected. Other companies have a proprietary architecture that everybody wants to build around and barriers to entry are high. The latter are known as gorillas. But even gorillas may wither away, as the area which they dominate may get less and less important. So we have to include that fact if we see it. Anyway, we multiply 1.5 by 1.42 by 1.36 by 1.33 etc. until we reach the probable time when the company is just average and is growing at 5-7% a year. At year Y what does our process predict for the earnings? If we want our stock to appreciate by 15% a year then we should have a reasonable P/E by year Y. Let me give an example. 1.5x1.3x1.1. This three year period gives a growth of 2.145 times. So if we expect that the P/E will be 20 after three years and the P/E is 30 now then the price will have grown from 30 times something to 42.9 times something, i.e. about 12% a year. If you want faster growth then you'll have to pay a lower P/E or else find a stock which will grow for a longer term.
