Say a retailer is profitable but earnings are low because cash flow from operations are being invested in expansion. It is growing 20% per year without taking on debt. It is trading at a P/E of 40 and analysts and bloggers say it is overpriced.
Not all money spent on expansion is good investment. It depends on how well or how sparsely the market is already covered. Each type of retail business has an optimum number of stores it can open. Eating places support more stores than, say, shoe vendors. If a retailer has a concept that can be replicated successfully across markets and has a low store count then you can expect the expansion to be profitable. Once the market is saturated the additional stores can be a costly mistake. At one point Starbucks over expanded and had to backtrack. I like retailers that have a low store count.
My rule of thumb is that 15 is an average P/E ratio, traditional industries can be had around P/E 5, good retailers around 25 and fast growers double or more that. But first you have to check that there is room to grow, not just how fast they grew in the past. And you have to check that the company is truly a growth medium.
The “S” curve is a good representation of growth. The bottom of the “S” (the curve in the hockey stick) is formed when about 15 to 20% market penetration is achieved. The top is formed at 80 to 85% market penetration. The best time to hold the stock is the middle period.
The “S” curve: https://www.google.com/search?client=safari&rls=en&q…
But, are there any useful rules of thumb for evaluating P/E is of growth companies growing in excess of 20% per year???
I believe Peter Lynch had such a rule of thumb but I don’t know it.
Denny Schlesinger