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Price earning ratio and growth rate
29 Dec 2022 (375 views)  

I will explain why a stock that has a high growth rate (of its revenue and earnings) can justify a higher price earning ratio (PER).

I consider a PER of 15 times to be "fair value". The stock price should be 15 times of the earnings per share (EPS). This assumes that the stock pays a dividend of 2% and is able to achieve an average growth of 5% in its earnings. This growth is mainly achieved by retaining a part of its annual earnings. 

A stock may be able to achieve a higher growth rate in its earnings due to:

a) Leading edge technology not available to competitors
b) Special market dominance through superior products or customer loyalty

If the growth rate is much higher than the normal 5%, the stock justifies a higher PER. 

The table below shows the PER that corresponds with the growth rate over the next 5 years. 

If the stock is able to achieve a growth rate of 50% per annum over the next 5 years, it can justify a PER of 89 times, instead of 15 times. 

Many stocks that are expected to grow better than average have a PER of 35 times. This implies that their earnings will grow by 25% annually.

Tesla stock used to have a PER of 100 times. It implies that their earnings over the next 5 years will grow by 55% annually. 

Prior to the recent slump in the stock price of Tesla, the projection was:

a) Sale of electric vehicle was expected to increase by 50% annually
b) The market will move towards electric vehicles over the next 5 to 10 years, giving a high demand for EV manufacturers. Tesla was the dominant leader in this category. 
c) Tesla is expected to improve its margin due to greater economy of scale.
d) Tesla had plans to build giga factories to meet higher demand. 

With the sharp correction in the stock price, the PER of Tesla stock has now dropped to 35 times based on 2021 profit or 20 times based on projected 2022 profit. 

I expect the PER to return to 50 times, indicating an earnings growth of 35%. This should be quite realistic. It would bring the stock price to $250.

Tan Kin Lian

Note - this is my personal observation. I am not giving "investment advice".
 

Price earning ratio and growth rate
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I will explain why a stock that has a high growth rate (of its revenue and earnings) can justify a higher price earning ratio (PER).

I consider a PER of 15 times to be "fair value". The stock price should be 15 times of the earnings per share (EPS). This assumes that the stock pays a dividend of 2% and is able to achieve an average growth of 5% in its earnings. This growth is mainly achieved by retaining a part of its annual earnings. 

A stock may be able to achieve a higher growth rate in its earnings due to:

a) Leading edge technology not available to competitors
b) Special market dominance through superior products or customer loyalty

If the growth rate is much higher than the normal 5%, the stock justifies a higher PER. 

The table below shows the PER that corresponds with the growth rate over the next 5 years. 

If the stock is able to achieve a growth rate of 50% per annum over the next 5 years, it can justify a PER of 89 times, instead of 15 times. 

Many stocks that are expected to grow better than average have a PER of 35 times. This implies that their earnings will grow by 25% annually.

Tesla stock used to have a PER of 100 times. It implies that their earnings over the next 5 years will grow by 55% annually. 

Prior to the recent slump in the stock price of Tesla, the projection was:

a) Sale of electric vehicle was expected to increase by 50% annually
b) The market will move towards electric vehicles over the next 5 to 10 years, giving a high demand for EV manufacturers. Tesla was the dominant leader in this category. 
c) Tesla is expected to improve its margin due to greater economy of scale.
d) Tesla had plans to build giga factories to meet higher demand. 

With the sharp correction in the stock price, the PER of Tesla stock has now dropped to 35 times based on 2021 profit or 20 times based on projected 2022 profit. 

I expect the PER to return to 50 times, indicating an earnings growth of 35%. This should be quite realistic. It would bring the stock price to $250.

Tan Kin Lian

Note - this is my personal observation. I am not giving "investment advice".