Growth

JW showed me the annual report of Manulife - a favorite stock of him, and an interesting one for me.

This highly respected colleague of mine has a special passion with growth stock. I am, alas, always skeptical about the future (and for which we two had several interesting, and fortunately not too colourful, discussion). He loves to quote the classical financial teaching, of which a stock with expected growth rate of 30% for the coming years (note the plural; it is not one year) can enjoy a PE ratio of 30 - and I am very hesitant to accept. Not only because a nominal yearly return of 3.3% seems too low to me, but rather for the fact that we can hardly be sure a certain business can have such a satisfactory growth for some years.

For example, if a stock has yearly earn of $1 and has expected growth rate of 30%, we can - by the growth stock valuation - give it an acceptable price of $30. Three years later, if the promise has been fulfilled, the yearly earn would be $2.2 (note the exponential growth). If the company has reached it limit and can no longer be regarded as a "growth stock", we would accept a PE of 10 to 12. The reasonable valuation, after 3 years of satisfactory growth, becomes $20 to $26.5 only. How can one accept this ?