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Equity | July 17, 2019

Does lower PE ratio means higher profitability?

Equity trading in India is filled with individuals who know the price of everything but value for nothing. PE ratio helps us in understanding the value of the stock. You might find a wonderful company but a good buy only makes sense if the price falls in the buying range.

So what is the PE ratio?

The PE ratio measures the relationship between a company’s stock price and its earnings per share of the stock issued. You can easily calculate this by dividing the current stock price by the Earnings per share. This ratio signifies how much an investor is willing to pay for the particular stock per unit of earnings. For example, if a stock is trading at a multiple of 10, the interpretation is that the investor is willing to pay Rs. 10 for Re. 1 of current earnings. It is one of the most widely used tools to date all across the globe.

Now let’s understand what does a high/low PE ratio mean in Equity Investments India?

Talking generally, a high PE ratio conveys the high expectations the investor has from the stock. The investor expects good growth out of it and the investment is called growth-style investing. However, a higher PE ratio also symbolizes that the investment is overvalued and you might run the risk of losing money.

On the other side investing in the low PE ratio companies, the investor believes the company is undervalued and will profit as the stock rises up. Such an investment style is called value investing. This doesn’t mean you should always invest in companies with low PE ratio, such companies might actually lack in real potential growth.

Bottom Line

Which company (low PE or high PE) should an investor focus on depends on a number of factors. Few of the factors are:

  • PE ratios differ by industry. Software companies will have a higher PE ratio than that of the textile industry. This doesn’t signify anything when compared; the companies must be compared amongst the relevant industry only.
  • You may use a low PE ratio for investing in a company if a similar peer company is trading at a higher PE ratio. You must keep in mind the peer company should be exactly the same.
  • You may also invest in a high PE ratio company provided the future earning justifies the investment.

While concluding, the above article emphasizes the importance of considering the PE ratio in relation to other factors when making investment decisions in equity trading in India.

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