DIG DEEPER

Investors chasing high-growth should prioritize near-term EPS explosion to justify high PE ratios, but also verify long-term business health and management before taking the plunge

In the dynamic world of financial markets, investors grapple with various factors when assessing a stock's attractiveness. Two pivotal elements that significantly sway stock valuations, or the price of a given stock, are the quantum of growth in earnings per share (EPS) and the quality of the underlying business.

This difference in valuation can be head-scratching. Why do some stocks trade at 40, 50, or even 70 times their earnings, whereas others stay stuck at 8 to 12 times earnings?

If you can figure this out, you might be able to identify those high PE stocks that are poised for "re-rating" - an upward adjustment in their PE ratio and become multi-baggers (stocks that experience significant growth) well before the crowd catches on.

The reason? Because if everything else remains the same, a ₹ 100 stock trading at 10 times its earnings would be worth ₹ 500 if valued at 50 times its earnings. This simple PE expansion translates to a whopping 500% return.

So, how is such a dramatic increase possible? This article dives into the nuances of these factors and aims to solve the equation for achieving a better PE ratio, which can lead to significant stock price appreciation.

First and foremost, there are two important factors that help companies or stocks improve their PE ratio.

• Growth In Earnings (EPS)

• Quality Of The Business

Let us first understand the growth in earnings or EPS:

Quantum Of Growth

Let's delve deeper into the first factor that grants companies a higher PE ratio, that is, the quantum of growth in earnings per share (EPS). Understanding this growth is paramount in evaluating a stock's potential.