In Chris Kacher and Gil Morales’s presentation on Pocket Pivots and Buyable Gap-ups, an audience member mentioned about William O’Neil’s P/E expansion method to get a growth stock’s target price.
I looked that up and found it mentioned in a few articles on investors.com (the website of William O’Neil’s Investor’s Business Daily). Basically, IBD’s research found the following:
- The best-performing stocks from 1953 to 1985 expanded their P/E ratios from 20 to about 45, i.e. 2.25x.
- The top 95 small-cap and mid-cap stocks from 1996 to 1997 experienced an average P/E expansion from 39 to 87, i.e. 2.23x.
- Leading stocks during bull markets typically expand their P/E ratios by 130%, i.e. 2.3x.
The starting P/E ratio is calculated from a “buy point”, which is the point of break out from a first-stage base. Hence to get to a price target for a growth stock during a bull run, do the following:
- Find the P/E of the stock at the point of break out from its first-stage base.
- Multiply that by 2.3 to get the target P/E ratio.
- Get the earnings estimate for 1-2 years out (depends on a rough estimate on the length of the bull run), and multiply that with the target P/E ratio, to get to the target price.
Note that this is what a growth stock can potentially achieve if it achieves a full run during the bull market. There are of course numerous other reasons that can impact the journey, e.g. earnings misses that can cause the stock to crash, etc.