Growth and PE correlation

To have the P/E ratio halve in 3 years, the Earnings Per Share (EPS) must grow at a compounded annual growth rate (CAGR) of approximately 15%, assuming the price remains constant. This is derived from the formula for compounded growth where if the P/E ratio is halved, the EPS needs to double, resulting in approximately 25.99% annual growth. However, a common shortcut for achieving a specific PE multiple decline is to recognize that a PE of 20 Halving to 10 in 3 years, requires an EPS to double, so the required 3-year annual growth rate for the EPS is around 26%. Here's the simplified calculation: 1. Goal: The P/E ratio needs to be halved in 3 years. This means the new P/E ratio will be half the old one. 2. Relationship: P/E = Price / EPS. If the price remains constant, and the P/E is halved, the EPS must double to achieve this. 3. CAGR Calculation: To double an amount in 3 years, you need a compounded annual growth rate (CAGR) that satisfies the equation: (1 + CAGR)^3 = 2. 4. Solve for CAGR: 1 + CAGR = 2^(1/3) 1 + CAGR = 1.2599 CAGR = 0.2599 or approximately 26% Therefore, if a company's price stays the same, it needs a consistent EPS growth of roughly 26% per year for its P/E ratio to be halved over three years. Important Considerations Price Stability: This calculation assumes the stock price remains the same over the three years. If the price also grows or falls, the required EPS growth will be different. Constant P/E: A company with a consistently high P/E ratio might suggest high growth expectations, but maintaining that P/E while EPS grows is not guaranteed. Industry vs. Individual Stock: EPS growth rates can vary significantly between industries. In summary: For a P/E to halve in 3 years with a stable price, EPS must double, requiring an approximate annual growth rate of around 26%.

by vijay