Sometimes, cheap stocks trade for more than 100 times earnings. Really:
Company |
2004 P/E |
5-Year Return |
---|---|---|
Frontier Oil |
210.4 |
258.3% |
Hess |
208.2 |
202.8% |
Arena Resources |
101.4 |
729.7% |
Hologic |
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 |
100.8 |
1,701.4% |
Goldcorp |
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
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
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.