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Don't ignore Stocks with high PE

CS Pankaj Khanna 
on 10 October 2011

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High PE Stocks can be good buys.

As a matter of fact investors keep an eye on price-earnings ratio (PE) before buying stocks & it’s the typical behavior of the investor to buy stocks with a low PE ratio in order to get superior returns compared with the ones who buys high PE stocks. However completely ignoring the high PE segment may not be a lucid idea as investors could be forgoing a good investment opportunity.

For instance, Educomp Solutions has generated an absolute 5 year return of 441% despite trading at a high PE of 44 in March 2006. It’s possible that a stock can have a high PE and still be cheap. It’s due to quality of management, good visibility of future and above all good corporate governance.. Here are four reasons under which a high PE stock would be a good investment is:

High Growth Expectations in Future

Beyond question the current share price is based on the expected future earnings and investors are willing to invest keeping in mind the future prospect of the company so a high PE in such a case would be very beneficial. A high PE stock may not be expensive relative to its growth prospect on the contrary  stocks which have low PE reflects  poor growth which in turn can PE predicted to have poor return.

Good & Strong Fundamentals

Strong Fundamentals will boost the company and will drive it to success in the long run. The factors include good management, strong brand equity, goo pricing power etc. The idea which crops up through this is that it is quite profitable to invest in such a stock then to risk the money where these factors are absent. Infosys, Titan Industries & Tata Motors are glaring examples.

Changing Nature of Industries

Changes and fluctuations in the industrial cycles may cause a high PE. Therefore valuation and assessing of companies which are changing in nature may not be truly reflected in their PEs. When there is a downturn the earnings are affected and PE appears high at the bottom but that does not signify that the stock price is expensive and that it will fall. In this type of cases the PE are artificial.

Big projects to be undertaken in future

High PE is generally a common trend in companies which have large projects in the queue or are planning huge expenditure.  Investors believe that the price they pay for such companies is low compared to the potential. If the company is unable to meet its obligations then the high PE may turn out to be unwarranted and on the contrary the market price will come down.

 

Therefore it can be concluded that taking any hasty decision just by seeing high & low PE may be a mistake. A high PE does not always means that the company is overvalued, just as low PE does not mean it is undervalued.




Category Shares & Stock
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CS Pankaj Khanna 

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