“You know why divorces are so expensive?” country music legend Willie Nelson once quipped, “Because they’re worth it.”
While ending a marriage may seem unrelated to investing in stocks, the truth is, when it comes to picking winners, the good ones are almost always expensive. It’s why growth investors like Joe Fahmy, managing director at Zor Capital, say if you’re looking for the big action, you can’t be put off by the high price.
“P/E is a good measure for some of the older companies,” Fahmy says in the attached video, “but you can’t use these traditional metrics to value companies that are revolutionizing and disrupting our lives.”
Contrary to the 'never overpay' philosophy of famed value investors like Warren Buffett, Fahmy says history has shown time and time again that avoiding stocks simply because they aren’t (or are barely) profitable is to miss huge opportunity.
“When you look back at winners, the biggest winners throughout history almost always trade at a high premium,” he says, at 1.5 to 2 times the P/E multiple afforded to the market.
While this thinking might run counter to the mindset of many market watchers, a look at the data makes a strong case.
For example, the ten best performing stocks in the nasdaq 100 right now, with gains over the past 12 months ranging from 83% to 398%, have an average forward P/E ratio of 68 times this year’s estimated earnings. That’s easily four times as expensive as the average stock that has delivered three to ten times the return of the market.
Fahmy uses Amazon as an example, a stock that has risen almost 600% in the past five years. Analysts expect the online retailing giant to show more than $70 billion in sales but only $300 million of net income. It works out to a PE ratio of over 500. And yet, few shareholders say the stock isn’t worth it.
“If you go by the price action, (eg AMZN shares +587% in 5 years) Wall Street is okay with what is going on,” Fahmy says. “Institutions continue to back the stock because they know Amazon is building out the future in so many different verticals.”
Going back further, Fahmy points to 2003, when Apple was trading at less than $10 a share. If you balked at paying 72x earnings, then you missed a ride that took shares of the iPhone-maker from $7 to $700.
“If you just use P/E as a measure you’re missing out on some of the greatest winners throughout history,” he says. “If you're a value investor you can use it. But for myself and people who are looking for growth stocks that can move over the long run, P/E is not useful.”