Naspers too expensive?

As I write this piece Naspers is sitting on a P/E of 54, with their major source of earnings, Tencent sitting on a P/E of 42. There are two reasons for having such high ratios, the first is that the current earnings are very low due to an unforeseen expense, or as is this case the market expects very high growth rates. Are these P/E ratios too high and the stock price unsustainable?

There is no doubt that if Tencent has a poor earnings result the stock prices will take a hammering, but what is more likely to happen is that the share price will slowly tick up while earning continue to blaze skywards, resulting in the P/E ratio coming down over time. If we assume that earnings will grow at 30% (which is a reasonable assumption given that the current six month earnings figure is higher than the 2010 full year figure) and that the share price grows at 15% p.a., in eight years' time, the share price will have more than doubled and the P/E ratio will be at 20. At which time Tencent will be a more mature company paying hopefully a substantial dividend compared to your initial investment.

One of the best case studies for buying a high quality, high P/E company is Google. Shortly after listing in 2004 the Google P/E was sitting at 93. From 2004 until 2012 earnings have grown by 1468% (not too shabby Nige) and the price was up 275% (up 370% on todays price), resulting in the P/E going from 93 to 22. Right about now I bet that you are thinking, "but Google was a no brainer buy", really? Would you have bought the company with a P/E of 93 (it wasn't too expensive?), would you have bought the company while the share price was halving in 2008 (it wasn't doomed like the rest of the economy?).

The general trend for high P/E stocks is for the earning to grow at a higher rate than the share price, which will bring down the P/E ratio as it gets harder to keep growing at over 25% p.a. The rationale for buying high quality, high P/E companies is that as an investor you want to lock in the purchase price early, watch the earning grow at a rapid pace and then when earning growth starts to slow, the company will start to pay out a dividend which will be a high percentage compared to your initial purchase price. The risk to buying a high P/E stock is that if growth is not as high as analysts estimate the share price will take a pounding, but I would still take that risk and overpay for a quality company's stock than underpay for an average company's stock.