Now, for the flip side of the argument. Just as it is a mistake to sell a corporation like Nike or Johnson & Johnson when the market quotation of the stock looks like it might have gotten a little overheated, there does exist a price at which holding onto a stock becomes foolish because the future returns will be so impaired by P/E compression that even a great company would lose its ability to create meaningful wealth from that price point.
The late 1990s provided a good illustration of when those mega-cap firms can get a little too pricey. Coca-Cola traded in the vicinity of 70x earnings. Since the summer of 1998, Coca-Cola has only returned 3.44% annually. That’s actually an extraordinary result under the circumstances, considering that Coca-Cola has spent the past eighteen years growing earnings to offset the brutal P/E compression from 70x earnings to the neighborhood of … Read the rest of this article!