It’s been awhile since I posted a Question of the Day.
This question is related to the my last post comparing MasterCard’s valuation with Visa’s. Here’s the question:
Is there ever a time when a high P/E ratio is justified for a stock?
There are a couple of ways to look at P/E ratios. Take Visa, for example. It’s trading at around $128 per share and has a EPS of $1.01, giving it a P/E ratio of 127. In order for that P/E to come down to a much more reasonable 20, one of two things must happen (or a combination of the two things):
1. The EPS must come up to $6.41 per share and the stock price stay the same.
2. The stock price must come down to $20.20 per share and the EPS stay the same.
3. Some combination of the two.
Stocks get bid up high like this because investors are optimistic as to the company’s future prospects. Sometimes investors get too optimistic.
Personally, I would not buy a stock with high P/E ratio like this.
What about you?