The first criteria 95% investors look at is P/E of the stock. And
higher the P/E is more expensive the stock is. So for most of the
investors, a general thumb of the rule is P/E ratio for the company
should not be, lets say, not more than 30. So, even if we have a great
company, which has very good business, good ROE, ethical promoters, in
short fulfills every other parameter you look in a company before you
invest, you still won't invest in a company which has high P/E ratio.
Now, let me try and break this myth. Here's the calculation:
As can be seen above in the base year, the P/E ratio of the company is 51, and we have assumed that the EPS will grow at 30%. so, even if the company goes through P/E de-rating and by the end of 20th year, the P/E ratio becomes 21, one would still get CAGR return of 24.3%.
That is effective to 77.5 times of increase in wealth i.e. if one would invest Rs. 1 lac, in a stock which would show P/E de-rating and grow its earning at CAGR of 30%, this Rs. 1 lac will become a cool Rs. 77.5 lac. Well the initial base year figures are of Symphony Ltd.
So, hopefully one you will next see a stock, you would dig deeper in see its potential and won't discard it on the fact that it trades at high P/E ratio.
Now, let me try and break this myth. Here's the calculation:
Base Year EPS | Base Year PE | CMP | ||
28.25 | 51.5 | 1454.875 | ||
Default Growth Rate | 30% | |||
Year | EPS in nth year | PE in nth year | CMP in nth Year | |
1 | 36.7 | 50 | 1836 | |
2 | 47.7 | 48 | 2292 | |
3 | 62.1 | 46 | 2855 | |
4 | 80.7 | 44 | 3550 | |
5 | 104.9 | 42 | 4405 | |
6 | 136.4 | 40 | 5454 | |
7 | 177.3 | 38 | 6736 | |
8 | 230.4 | 36 | 8296 | |
9 | 299.6 | 34 | 10186 | |
10 | 389.5 | 32 | 12462 | |
11 | 506.3 | 30 | 15189 | |
12 | 658.2 | 29 | 19087 | |
13 | 855.6 | 28 | 23957 | |
14 | 1112.3 | 27 | 30032 | |
15 | 1446.0 | 26 | 37596 | |
16 | 1879.8 | 25 | 46995 | |
17 | 2443.7 | 24 | 58650 | |
18 | 3176.9 | 23 | 73068 | |
19 | 4129.9 | 22 | 90858 | |
20 | 5368.9 | 21 | 112747 | |
CAGR returns | 24.3% |
As can be seen above in the base year, the P/E ratio of the company is 51, and we have assumed that the EPS will grow at 30%. so, even if the company goes through P/E de-rating and by the end of 20th year, the P/E ratio becomes 21, one would still get CAGR return of 24.3%.
That is effective to 77.5 times of increase in wealth i.e. if one would invest Rs. 1 lac, in a stock which would show P/E de-rating and grow its earning at CAGR of 30%, this Rs. 1 lac will become a cool Rs. 77.5 lac. Well the initial base year figures are of Symphony Ltd.
So, hopefully one you will next see a stock, you would dig deeper in see its potential and won't discard it on the fact that it trades at high P/E ratio.