Ask Colin

I am looking at buying growth companies with a PE ratio of 15-25, providing the PEG ratio is 1 or less. What do you do?

Although I do not myself use the PEG ratio, I have a rough guideline that the percentage growth in earnings should be around the PE ratio for the stock. I prefer to put it this way and leave the precise definition a bit flexible, because I find that hard and fast rules can sometimes catch a weak company but just exclude a strong one. Sometimes the one year earnings growth is the best guide and other times the two or three year growth is better.

My approach with growth stocks is to find them as indicated by my growth model as described in my book being published progressively on my subscription website and also in Shares Charting Guide No 1 (also available on my subscription website).

Having found one that is breaking above a consolidation zone or trending upward strongly, I will consider the PE ratio and earnings growth, but flexibly as described. The stronger the trend the more aggressive I am inclined to be with those fundamental ratios. Strength is everything with growth stocks.

However, it has to be within reason. If the company is growing earnings at 50% pa and the PE is 40, I may still not buy it. No business can grow at 50% pa for long. As they say in the market, "no tree grows to the sky". If you have missed the early years of the growth story and the market is now paying silly prices you are being a fool, hoping a bigger fool will come and buy it from you at even sillier prices in the future. This is not a good bet. Leave it for the mug punters.

I think your guidelines will keep you out of most of these silly-priced stocks, but just sometimes a stock like this could fall into your criteria. Do not be too reliant on sheer numbers. Keep the brain working for the basic commonsense of the situation.

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