P/E and Growth Assumptions

CFA General
#1

I am wondering if there is any general truth in below statements between growth rate and P/E ratio:

"A company that’s projected to grow at 20% per year for the next three years should have a P/E of 19.78.

But if our outlook is bearish and we expect just 10% growth, we should be willing to own shares at maximum P/E of 15.48.

On the other hand, if we think growth will be 30% per year, we should be willing to own at a P/E of 24.83."

Link: https://seekingalpha.com/article/4217613-rational-assessment-facebooks-share-price

#2

Certainly there should be a positive relationship between a company’s growth and its P/E ratio.

#3

I would say there’s a pretty direct correlation. Probably why companies that trade at 40x and see their growth “slow” to 15% annually get hammered 20% on earnings. High P/E = High expectations, vice versa.

Trying to nail down exact P/E numbers is just silly IMO. “I’m only going to buy under a P/E of 17.32908628407, and not a bit more”

#4

the gist of it makes sense…but the whole thing is fishy as in amateur hour writeup.

I remember some guy on SA with massive “followers” said Tesla’s NI is down due to huge ramp up of R&D in building Model 3 and production factories this quarter…He went on to say that operating cash flow will soon…blah blah with a whole bunch very convincing and pretty charts and reasons…

Now what is wrong with his statement? CFA level 1 Question material right here.

#5

there is definitely a positive correlation, but the the stability of the earnings is the real issue. typically with cyclical companies , you’ll find that their multiples will be very cheap during the worst time to buy them (earnings about to dip or go negative)! and they will be very high during the best times to buy them.

to determine stability of earnings, its really dependent on the business/industry, the number of historical data they have, their market share, the type of competition they have. if they’re growing rev per customer. etc etc.

as some people mentioned there are different stories for different companies.

some will focus on book value relative to price. most likely they will have negative pe.

some might focus on cyclical companies, these will have much lower pes relative to market, and maybe negative. (earning volatility issue)

some might focus on stable companies, they will be either at market or at a premium, they’ll be levered, generating a dividend, with basically barely any growth. (overall multiple issue)

some might focus on growing companies, they will have high or negative pes, their rev/eps growth will be double digits. (price volatility issue)

#6

This is definitely true to a point. Alot of companies went low P/E in 2007 and people used that as justification for buying that. Oops.

Conversely, P/E’s skyrocketed in 08/09/10 because earnings were in the gutter.

That being said, when a cyclical company is doing well (not at bottom of cycle) and margins are near a high point for them and the P/E is high, as a value guy I could never touch it.

#7

there are funds that target growth stocks and there are funds that target value stocks…Now growth stocks have high P/E and P/B etc while value stocks have low P/E and P/B etc…But both make money during bull markets and both get slaughtered in bear markets.

Which tells me no one knows what the heck is going on…now the fab is multi factor portfolio hahaha…it works great in attracting investors because you can make it look really complicated although it is all crap…but it’s all about the show in this business…