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The ideal situation that contributes to hundred bagger returns for investors is a situation in which both earnings and the earnings multiple of a given stock rises for years if not decades on end.
For instance, consider the stock of Nvidia, which has gone up over 100 fold since the turn of the millennium — and, at the time of this video, is still rising.
The power of simultaneous increases in both earnings and the earnings multiple can really be seen in the dramatic move the stock made from the end of 2011 through 2017.
In Q4 of 2011, NVDA had a price/earnings ratio of approximately 15.63, and reported operating income of just over 600 million US dollars.
By October of 2017, NVDA had a price earnings ratio of 57.24, and operating income of over 2.87 billion US dollars.
This dual increase in both earnings and the earnings multiple enabled it to provide 100 fold returns to its investors.
As such, investors who focused only on traditional valuation ratios like Price/Earnings may have found this stock to be overvalued, and thus exited it prematurely or skipped it entirely and missed gains accordingly.
So, what is a way to understand valuation for hundred bagger candidates, and thus determine when the market has truly given it an unsustainable valuation?
One resource might be the Price/Earnings Growth ratio, also known as the PEG ratio.
The PEG ratio is calculated by simply taking the Price/Earnings ratio and dividing it by the growth rate in earnings the company has been achieving.
For instance, during NVDA’s run from 2011 through 2017, its average P/E was approximately 27, and its average earnings growth rate was approximately 22%, resulting in an averaged PEG ratio of just 1.23.
Historically, a PEG ratio below 2 suggests the stock’s valuation may not be out of line with its growth potential.
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