High P/E Ratio Stocks: Be wary and think growth

A high p/e ratio isn't always a bad thing. In fact, it can be useful in indicating positive future performance. A high p/e ratio can be indicative of good relative price strength and high earnings growth, albeit the fundamentals may be skewed. Think of stocks with high p/e ratios as a certain type of investing. It is simply growth investing.

As always in finance, reward does not come without its risks. A stock with a high p/e ratio is one which carries risk. As a side note, value investors do not generally see high p/e ratio stocks as ones worth analyzing because of the following principle: a value stock is one which has a low p/e ratio (price earnings multiple). Growth investors on the other hand will seek out high p/e ratio stocks because the payoffs can be great.

When looking to invest in stocks with high price earnings multiples, one should be wary. It is necessary for successful investing to seek out the following for high p/e ratio stocks: The company should have earnings projections that are proportionate to the p/e ratio. The company should have a product or service that would easily become a household name, or at least one that provides a bonafide benefit to society. Finally, the price of the stock must show relative strength for the justification of a p/e ratio.

Earnings Growth

When the future projections of earnings are healthy and strong, naturally the stock will perform that way too. High p/e ratio stocks need to have high earnings growth.

Potential Consumer Products

Most of the products or services that companies provide to its customers are ones that benefit society. A company could not stay in business otherwise. The companies that would do the best in high p/e ratio investing are ones that create a product or service that has the potential to become a household product. Over recent history the trend in the corporate world has been to create a household name by different means; such as, information technology companies and those creating peripheral items that catch a major wave for consumer demand in the market. Knowing the industry and being able to analyze different components of major industries, especially the information technology industry, can benefit a stock investor greatly in this category. However, keep in mind that growth investors will look for those companies who can not only produce wide reaching products and services to the public, but can become a household name. This is a major component to William O'Neil's CAN SLIM investing approach. In it he recommends investing in companies that have the potential to become a household name with household products that are made with ingenuity. William O'Neil has been known as one of the pioneers of modern growth investing.

Relative strength

Relative strength can be defined as the ability to hold the price up during down times in the market as well as the better than peer performance during upswings. There is a strong correlation with relative strength and high p/e ratio stocks.

 

 

blog comments powered by Disqus
Scottrade