Page 291 - How to Make Money in Stocks Trilogy

A = Annual Earnings Increases: Look for Big Growth 169

If a company’s price and P/E ratio change in the near future, it’s because
conditions, events, psychology, and earnings have continued to improve or
started to deteriorate. Eventually, a stock’s P/E will reach a peak, but this
normally occurs when the general market averages are topping out and
starting a significant decline. It could also be a signal the company’s rate of
earnings growth is about to weaken.
It’s true, high-P/E stocks will be more volatile, particularly if they’re in
the high-tech area. The price of a high-P/E stock can also temporarily get
ahead of itself, but the same can be said for lower-P/E stocks.

Examples of High P/Es That Were Great Bargains

In situations where small but captivating growth companies have revolu-
tionary new products, what seems like a high P/E ratio can actually be low.
For instance,
• Xerox, which introduced the first dry copier in 1959, sold for 100 times
earnings in 1960—before it advanced 3,300% in price (from a split-
adjusted $5 to $170).
• Syntex, the first company to submit a patent for a birth control pill, sold
for 45 times earnings in July 1963—before it advanced 400%.
• Genentech, a pioneer in the use of genetic information to develop new
wonder drugs and the first biotech company to go public, was initially
priced at 200 times earnings in November 1985. In five months, the new
stock bolted 300%.
• America Online, whose software gave millions access to the revolutionary
new world of the Internet, sold for over 100 times earnings in November
1994 before climbing 14,900% to its peak in December 1999.
• Google’s P/E was in the 50s and 60s from $115 a share in September 2004
until it hit $475 a share in early January 2006.
The fact is, investors with a bias against what they consider to be high
P/Es will miss out on some of the greatest opportunities of this or any other
time. During bull markets, in particular, such a bias could literally cost you
a fortune.

Don’t Sell High-P/E Stocks Short

In June 1962, when the stock market was at rock bottom, a big Beverly Hills
investor barged into the office of a broker friend of mine and shouted that,
at 50 times earnings, Xerox was drastically overpriced. He proceeded to sell