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Creating a Portfolio Like Warren Buffett: A High-Return Investment Strategy by Jeeva Ramaswamy

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CHAPTER 21

Stock Research Checklist—Stock Price

Does the Company Trade at a P/E Ratio That Is Less than Its Growth Rate?

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If you buy stock at too high of a P/E multiple—even after all the research checklist items are passed—you will not be able to make a profit on your purchase. To determine this, first calculate the company’s growth rate for the last 10 years. The simple calculation should show that the P/E ratio is less than the company’s long-term growth rate. If the company is growing at 20 percent over the last five years, consider buying the stock for less than 15 times conservative future earnings. Never buy stock at or above 20 times conservative future earnings.

When you are dealing with high-growth stocks, this simple calculation should be remembered at all times. The stock of high-growth companies trades in higher multiples most of the time. Whenever there is any bad news that is related to the company, the industry, or a severe market sell off, the high-multiple stocks sell off badly. You should use that opportunity to buy the stocks when the price is low and earnings multiples are less than the growth rate. If the stock does not fall enough, do not buy the stock.

When you are calculating the P/E multiple, do not rely on the current P/E ratio, which is calculated using the previous year’s earnings. To get the proper calculation, consider using the historic average earnings ...

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