I recall in the webinar and the online lesson, the typical PE ratio for overvalue and bubbly is >25 while the alpha case study of mktx is around 50 and yet was considered as fair value and was bought. I understand that IQ system considered fair value to be the average PE over a period of 5-10 years. In current USA market where there is some froth and especially for growth companies, the pe multiples can be really high. Are we joining the bandwagon without considering the true earning power of the company? Are there alternative valuation methods to cross check with average PE ratio to ensure we are not overpaying?
The lesson that I had taught about >25 is bubble is the index not individual stocks.
For the average PE valuation, you can cross check it with their growth rate. For instance, if the company have an average PE of 100x but their growth rate for the past three years or 5 years is 19% then I will not purchase them even if the company is at average.
If you are uncomfortable with the high valuation, you can always wait for the company to drop to a suitable margin of safety for you to purchase. Remember investing is a patience game where you wait for the probability to tilt to your favour.
Thanks Victor. Is there some rule of thumb or guideline for growth rate vs PE?
For example you quote 19% growth and 100 PE indicates overvalue. Then for 19% growth, what should be the fair PE?
I notice Lynch (1989:199) argues that a P/E ratio of double that of the growth rate means the stock price is due for a comedown. But that if you could find a company with a P/E ratio of half its growth rate you’ve found a bargain. My calculation of Market Axess’ CAGR is 24%, more than half the P/E.
Hi Erastus Jonker,
The guideline that Peter Lunch had given is a general rule of thumb but when it comes to investing it may vary. The best case scenario is to buy at what Peter Lynch had mentioned. It most cases when the company is growing, it is hard to get the PE at half the growth rate. Usually when that happen, there will be a lot of bad news about the company. Moreover, during Peter Lynch era, the type of companies are different as compared to now which are more asset light in nature.
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