What do high PE ratios mean for growth stocks?
In the preceding part of this series, we discussed how investors look at price ratios—the PE (price-to-earnings) ratio, in particular—to determine whether a stock’s current stock price fairly values the company in terms of its fundamentals. However, the technology industry is undergoing a major transition to AI (artificial intelligence) and IoT (Internet of Things), wherein the growth possibilities are enormous.
This transition has created some growth stocks that have lower earnings right now, though these stocks have the potential to multiply earnings by two to three times over the next few years. For this reason, stock prices have factored in future growth, making them an expensive stocks based on their current valuations.
If we look at its PE ratio of 48.85x, NVIDIA (NVDA) is considered an expensive stock at its current price of $197. This price is lower than its 52-week high of $218.67 and its consensus price target of $226.5, as the stock’s price has corrected during the semiconductor stock price correction at the end of November 2017.
However, analysts are bullish on NVIDIA because it’s a growth stock that still has huge untapped opportunities in the autonomous driving space and in other AI (artificial intelligence) applications. Many analysts believe that the correction in the stock’s price is a good buying opportunity for those who failed to participate in the stock’s growth spree.
Analog Devices and Integrated Devices Technology
Analog Devices (ADI) was one of the semiconductor companies with the largest revenue growth. This strong revenue growth has increased optimism among investors and pushed the stock into the overbought category. The stock looks fundamentally expensive at the current price of $88.6, but analysts expect this high price to become the new normal and the stock to grow to $100 over the next 12 months.
Integrated Devices Technology (IDTI) is a similar case, with analysts expecting the stock to grow from $30.4 at present to $35 over the next 12 months.
But Qualcomm (QCOM) is in a different situation. Its PE ratio rose to 39x as its stock price jumped at the start of November 2017, from $51 to $64, after the news of Broadcom’s hostile takeover bid was leaked. The PE ratio increased its EPS (earnings per share) continued to fall amid its licensing dispute with Apple (AAPL).
Qualcomm has a strong growth opportunity as it acquires NXP Semiconductors (NXPI) and rolls out 5G technology, but its regulatory concerns are creating uncertainty around its capability to tap future growth, making it an expensive stock.