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LORD JESUS CHRIST SAYS

“Ask and it will be given to you; seek and you will find; knock and the door will be opened to you. For everyone who asks receives; the one who seeks finds; and to the one who knocks, the door will be opened. Matthew 7:7-8

26 Mar 2017

SHARE MARKET-- PE ratio—How it helps Investors to buy great stocks.

Introduction to PE ratio: PE ratio is one of the most widely used tools for stock selection. It is calculated by dividing the current market price of the stock by its earnings per share (EPS). It shows the sum of money you are ready to pay for each rupee worth of the earnings of the company.
PE = Market price / EPS
Assume there are two companies 'A' and 'B', operating in the same sector. If PE of 'A' is 30 and PE of 'B' is 22, then 'B' is considered to be a better buy, as the market price has not gone up to reveal the earnings prospects of the company. But 'A' is considered to show higher growth prospects as compared to 'B'.
How does PE help?
Understanding PE gives the investors an idea if the stock has sufficient growth potential. Stocks with low PE can be considered good bargains as their growth potential is still unknown to the market.
If the PE is high, it warns of an over-priced stock. It means the stock's price is much higher than its actual growth potential. So these stocks are more liable to crash drastically. This was evident in the recent market crash when the stocks of all Reliance companies fell sharply.
This will allow savvy investors to sell their holdings before the stock price crashes.
Drawbacks of PE ratio
Interpretation of PE ratio is heavily dependent on comparison of the company with its peers. Also PE that is considered very high in certain sectors can be considered very low in other sectors.
For instance, companies in IT and telecom sectors have higher PE ratio than the companies in manufacturing or textile sectors.
Also PE ratio is not totally neutral. Any major announcement of a major order or acquisition by the company will certainly push up its PE. On the other hand, low PE may not indicate a good buy but could signify more serious issues facing the company. So it is very important to perform a thorough research into the background of the company, before investing.
Besides EPS itself is assumed, as it forecasts future growth based on past performance. However, there is no guarantee that the company can continue to maintain its performance each year. Also the sector in which the company is operating may experience problems as was recently seen for the IT sector.
So PE ratio cannot be considered to be a totally reliable indicator of cheap, good stocks.
Yet, PE ratio remains one of the most important ratios when it comes to stock selection.Dont buys shares more than industry PE. Before going to purchase low PE shares, please verify the company’s fundamentals like pledging of shares by promoters, minimum 5 years annual report, dividend paying history etc.


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