The P/E ratio of any company that’s fairly priced will equal its growth rate. I’m talking about growth rate of earnings here…. If the P/E of Coca-Cola is 15, you’d expect the company to be growing at about 15 percent a year, etc. But if the P/E ratio is less than the growth rate, you may have found yourself a bargain. A company, say, with a growth rate of 12 percent a year and a P/E ratio of 6 is a very attractive prospect. On the other hand, a company with a growth rate of 6 percent a year and a P/E ratio of 12 is an unattractive prospect and headed for a comedown.
In general, a P/E ratio that’s half the growth rate is very positive, and one that’s twice the growth rate is very negative. We use this measure all the time in analyzing stocks for the mutual funds.
Peter Lynch – In One Up on Wall Street