Page 1028 - How to Make Money in Stocks Trilogy

The CAN SLIM Investment System 21
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• WHAT ABOUT P/E RATIOS? •
You may have noticed there was no mention of price/earnings (P/E)
ratios among the 7 traits of winning stocks. The reason is simple: Our
studies show P/E ratios (share price divided by earnings-per-share) are
not an important factor in a stock’s price movement and have very lit-
tle to do with whether a stock should be bought or sold.
That may come as a shock since most investors are told to focus on
stocks with a low P/E ratio and avoid those with a high one. But the fact
is, 130+ years of market history show that investors who fixate on
low P/E ratios miss out on virtually every big winner.
Here’s why.
A low P/E ratio is usually a sign of weakness, not strength. The
strongest stocks—those with big earnings growth and other CAN SLIM
traits—will typically have a higher P/E ratio. Why? Because institu-
tional investors are willing to pay more for quality, fast-growing stocks.
A baseball team has to pay more to sign a .300 hitter averaging 40
home runs a year than to sign a benchwarmer with a .200 batting aver-
age. As the table below shows, it’s the same in the stock market: You get
what you pay for.

P/E Ratios of Leaders in 2009–2012 Bull Market
Company Year Run Started P/E at Start of Run Subsequent % Gain
Baidu 2009 69 322%
Green Mountain Coffee Roasters 2009 36 1104%
Priceline.com 2010 29 183%
Lululemon Athletica 2010 33 196%
SolarWinds 2011 28 137%

If you focus only on low P/Es, you’re essentially taking the best mer-
chandise off the shelf and restricting yourself to the clearance bin. So
instead, focus on stocks with big and accelerating earnings growth.
That’s the true mark of a potential big winner.