Its fairly intuitive that a company with a high CAP and high ROE should have a high PE. But these permutations have thrown a few insights
- For similar CAP and growth rates a company having an ROE of 20 % should have a PE which is 1.3-1.4 times that of a company with an ROE of 10%. Similar ratios come up for every 10% increase of ROE
- Companies with moderate ROE ( 10-15 %) need CAP of more than 10 years to justify a PE of 20 or higher
- Companies with PE of 30 or higher need a CAP of 10 + years with a growth of 15% and ROE of 25% or higher
So any time I see a company with PE of 20 or higher (which is high these days), the first question I ask is – Given the ROE of the company, does the company have substantial duration of CAP ( 10 years or higher ).
A company with a PE of 30 or higher must have a great return on capital, very strong growth and 10 years or higher CAP. A point worth thinking about when looking at such high valuation companies.
This way of think is detailed in the book ‘expectations investing’ by micheal maubossin and is definitely worth a read.