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.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.