Why do they pay even though there is such a high price/earnings ratio?
Well, most investors want very high growth – High Growth stocks will have a higher P/E ratio. As You probably know, the P/E ratio is the real measure of a companies "Value"
Here's an interesting thing to start looking at….it's the "PEG ratio"
PEG ratio equal (Forward P/E ratio / 5 year estimated growth)
NOTE: a PEG ratio = 1 equals perfectly valued (in some peoples opinion)
A higher PEG ratio means, or can mean, it's more expensive.
Let's take a look at two comparable companies…..in the same sector. Let's look at Hewlett Packard and Dell Computer.
HPQ
Forward P/E: 12.31
5 year estimated growth: 15.59%
* PEG ratio = .86
DELL
Forward P/E: 12.83
5 year estimated growth: 12.41%
* PEG ratio = 1.13
As you can see, Dell has a higher "PEG" ratio than Hewlett Packard, even though Hewlett Packard has a higher growth rate. Therefore, it can be argue that Hewlett Packard is "cheaper"
NOTE: If a stock has a high P/E it BETTER have a high growth rate. If you invest in it, you had better be sure that it's growth will be great moving forward.
Many people ask why stocks are so volatile…well, day to day when a stock moves………..The Forward P/E ratio is what is really moving the stocks value so much.
Complicated – I know! But you just can't look at one variable you've got to weigh in everything.
YahooFinance is a great tool. When you are looking at your stocks, you can click on the link "key statistics" and find some great information.
But I think that the Forward P/E and the PEG ratio are great tools to get a good idea about how a stock is valued compared to how it is growing.
I hope I've helped….long answer…