When we compare and judge stocks, we can use all kinds of ratios and statistics to separate the good from the bad. Yet when you find a good one, what’s a good price to pay for them? You can base it on past performance or forecast growth.
That is the dilemma every investor has to go through when considering buying a stock.
The tried and true price/earnings ratio is an easy and, unfortunately, subjective number that investors can use. Usually the one you see quoted most with a stock’s price is based on the most recent annual earnings. It’s helpful when looking at several companies in the same industry to get a general sense of relative value.
The trouble is that the earnings data is from the most recent year only and doesn’t reflect any change, real or perceived, that may be coming to the company’s business. We could use a forward expected earnings value, which many people do, but if people can’t reliably predict what future earnings will be even just one half-year ahead, then the ratio is flawed at best. One bad year could follow one great year, or vice versa and the ratio goes awry.
Here are three companies with great earnings per share growth in the past year – at a higher percentage rate than their current PE ratio.
Credit Corp Group Limited (ASX: CCP) ($9.13)
One-year earnings per share (EPS) were up 19.4% and its PE is 12.2
TPG Telecom Ltd (ASX: TPM) ($5.82)
One-year EPS grew 63% and its PE is 26.9
Primary Health Care Limited (ASX: PRY) ($4.67)
One-year EPS were up 28% and its PE is 14.4
Our only practical way to say a price is reasonable or too high is to know the history of companies, follow their progress closely and be willing to pay a reasonable price for good growth.