PE Ratio (multiple)

Stocks Which Are Profitable, Not Expensive

Investors should strategically buy stocks or sectors that are riding the boom. When markets are slipping, things are just the opposite. Some investors say, ‘buy in a falling market’, but it would be difficult to put your finger on one sector or stock as the right one. But sometimes the idea would be right. Bottom line – investing becomes confusing.

To identify good stocks, investors estimates various ratios like dividend-yield, price earning to growth, price to book value, price to earnings, etc. Investing by analyzing PE ratio (multiple) is like looking for discounts while shopping. Lower the PE, lower the amount investors are willing to pay for it and vice versa. However, some stocks like L&T and HDFC will command a very high PE multiple, because of the investor confidence on these stocks.

Now that the various stocks have corrected by 60-70% of their value, investors refuse to pay high price to buy them. Some savvy-shoppers try to avoid paying too much by buying low PE stocks.

Example:
Company XYZ- stock price- 500
EPS-20
Therefore, PE = 25.

Company ABC- stock price – 1,000
EPS-20
PE=50.

Market does not look at whether EPS is similar. It is more important in growth in EPS. Company’s PE ratio normally reflects investors’ expectations for future growth in EPS.
Market sentiments play a big role in pricing. Thus PE ratio may not necessarily reflect reality. In this case investors are willing to bet even on high PE stock because according to them, present valuation is cheaper than what it should be. Thus it is important that an investor not only looks as the PE ratio but also at the earning growth prospects over next several quarters.