I can certainly understand why someone might have the urge to take some of his discretionary funds and put it into shares of extreme high growth companies. After all, Apple (NASDAQ:AAPL) has managed to grow per share earnings from $0.10 in 2003 to $35.11 over the trailing twelve months. Since then, the stock price has gone from $8 per share to around $600. A $25,000 Apple investment at $8 in 2003 would have bought you 3,125 shares now worth $1,800,000. You can't even get those kinds of returns with ski masks and pistols. So I get the lure of these companies for investors. Really, I do.
Google (NASDAQ:GOOG) has grown its share price from $85 in 2004 to $646 today, and Amazon (NASDAQ:AMZN) has grown from its low share price of $18.50 in 2003 to $192 today. Naturally, the rearview mirror of investing is much clearer than the wind shield. As Buffett has said multiple times, "The investors of today do not profit from yesterday's growth." Likewise, when I think about the wisdom of purchasing shares in high growth companies, the wisdom of Benjamin Graham comes to mind, "On what terms? And at what price?"
For me, I can easily understand why Google, Apple, and Amazon have worked out so well for investors over the past five years. You had two great things working together: extreme growth combined with a purchase price that left room for the investor to benefit from such growth. Over the past five years, Google has grown its earnings by 55% while having an average P/E ratio of 28. For that type of growth, the P/E ratio of only 28 was a godsend for investors. Likewise, Apple has been able to grow earnings by 64.5% over the past five years while having an average P/E ratio of only 24. And in Amazon's case, the firm has been able to grow annual earnings by 24% annually while having an average P/E ratio of a little less than 50, which takes us to the inflated price that we're at today.
Now let's take a look at what analysts are predicting for the next five years. Google is expected to grow earnings by 20% annually for the next five years, Apple at 25%, and Amazon at 26.5%. For our premise, let's just assume that the analysts are right (and yes, I do realize this is a big 'if'), and each of these three companies grow by that amount over the next five years.
But let's not forget that it is not only high growth that made these companies such successful investments over the past five years, but the opportunity to buy that high growth at a reasonable price as well. They say a picture is worth a thousand words, so let's take a quick look at the current P/E ratios of Google, Apple, and Amazon:
The current P/E ratio for Amazon stock does not strike me as something that gives investors much room for error. If my goal is to buy the greatest amount of future profits at the best risk-adjusted price, the current risk-adjusted price of Amazon shares do not offer much in terms of a margin of safety.
*Quick Side Note On How I Think About Buying Future Profits*: Let's say I was considering whether to invest in shares of Kimberly Clark (NYSE:KMB) or Apple . Apple currently lets you buy shares for 17.07x earnings, and Kimberly-Clark is trading at 18.38x earnings. Apple is expected to grow earnings at 25% annually for the next five years, and Kimberly-Clark is expected to grow earnings at 7% annually over that same time frame. So Apple currently lets you buy profits that are expected to grow at over triple the rate of Kimberly Clark's for a slightly cheaper price. Unless I think: (NYSE:A) Kimberly Clark will grow earnings at a faster clip than analysts estimate, (NYSE:B) Apple will grow earnings at a slower clip than analysts estimate, (NYSE:C) Kimberly Clark's current and future dividend generation is worth the trade-off, (NYSE:D) Kimberly-Clark has a stronger moat that translates into lower risk or (NYSE:E) some combination of those factors, then it would appear that Apple would be a better bang for my buck over the medium term in terms of buying future profits.
It's hard for me to see the wisdom of buying shares of Amazon at the current price. Value Line predicts that Amazon will post earnings per share of $8.15 by 2016. Okay, at the current price of $192.40, that's a future P/E ratio of 23.6 for earnings five years down the road. You can currently lay claim to a greater amount of earnings by investing in either Google or Apple today, and in the case of Amazon, you'd have to wait five years for those optimistic earnings to materialize. For Amazon to be a successful investment at this price, everything has to go right. Apple and Google, on the other hand, seem to offer much larger margins of safety with P/E ratios of 17 and 21, respectively. I'm not saying that Amazon at $192 won't prove to be a good investment for potential investors at the current price. But when you're paying over 100x earnings for a stock, your investment thesis becomes: "This company is like the 1972 Miami Dolphins. All it's going to do is win."
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.