Sometimes, cheap stocks trade for more than 100 times earnings. Really:
|
Company
|
2004 P/E
|
5-Year Return
|
|
Frontier Oil (NYSE: FTO )
|
210.4
|
258.3%
|
|
Hess (NYSE: HES )
|
208.2
|
202.8%
|
|
Arena Resources
|
101.4
|
729.7%
|
|
Hologic (Nasdaq: HOLX )
|
118.9
|
156.4%
|
|
Calgon Carbon
|
100.9
|
119.9%
|
Source: Capital IQ, a division of Standard & Poor's.
Five stocks, five multibaggers. But to get those returns, you had to buy these winners when they were trading for a triple-digit P/E.
Crazy.
Or is it? According to Capital IQ, there were 21 stocks trading for at least 100 times earnings five years ago that have since produced positive returns. The market fell 20% over the same period.
Bursting the value bubble
Of course, I'm cherry-picking here. So, let's try another awful five-year stretch -- from January 2000 to January 2005. Stocks were down roughly 12% over that period, yet Capital IQ found 23 premium-priced winners, including these three multibaggers:
|
Company
|
2000 P/E
|
5-Year Return
|
|
Ceradyne (Nasdaq: CRDN )
|
100.8
|
1,701.4%
|
|
Goldcorp (NYSE: GG )
|
188.7
|
754.9%
|
|
Harman International
|
124.9
|
753.8%
|
Source: Capital IQ, a division of Standard & Poor's.
It's true that we can't take high P/Es as predictive of great returns. But it's probably fair to say that a 100-or-better P/E, in and of itself, shouldn't disqualify a stock from your consideration.
High = buy?
In fact, if you're David Gardner, it may even be a buy signal.
Documented evidence that the mainstream financial media consider a stock overvalued -- which a high P/E may signal -- is one of David's criteria for a company that may become a Rule Breaker, a firm whose innovative prowess transforms its chosen industry, unleashing billions in market value.
"The reason [a premium valuation] is valuable is that it keeps people out of a stock; later on, as the company proves out its position as a profitable, even dominant, leader, then the skeptics finally buy -- which is what can give you serious appreciation as an early investor," David wrote in 2006.
But media skepticism is only one of the six signs of a rebellious winner. The other five:
- Top dog and first mover in an important, emerging industry.
- Sustainable advantage gained through business momentum, patent protection, visionary leadership, or inept competitors.
- Strong past price appreciation.
- Good management and smart backing.
- Strong consumer appeal.
The next 100 P/E winner
Very few richly valued stocks ever become Rule Breakers. But when all six signs truly do come together in a single stock ... Wow.
Take Apple (Nasdaq: AAPL ) . In the 12 months leading up to January 2004, its stock had risen 60% (past price appreciation) thanks to the iPod (top dog, consumer appeal), which caught fire after CEO Steve Jobs ordered a version of its iTunes Music Store built for Windows (good management, visionary leadership). Months before, in May, Barron's had cited "concerns over valuation" (expensive).
Apple, which suffered with a triple-digit multiple for much of 2003, is why I'll never again simply pass over a stock that trades for 100 times earnings -- stocks like Teradyne and current Motley Fool Rule Breakers winner BioMarin Pharmaceuticals (Nasdaq: BMRN ) .
But my favorite is one that you don't see here. It's my latest pick for Rule Breakers, a premium-priced stock that gushes cash and leads in the development of one of the world's most promising new technologies. I believe it's a misunderstood multibagger in the making, and I'll be buying shares when disclosure rules allow.
Interested? Click here for 30 days of free access to Rule Breakers -- you'll get the name of that stock, as well as our team's five top growth stocks for new money.
Fool contributor Tim Beyers had stock and options positions in Apple, a Stock Advisor selection, at the time of publication. Tim is a member of the Rule Breakers team, which counts Ceradyne and BioMarin among its holdings. Its disclosure policy lives richly every day so that you can, too.
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