LOW P/E OR HIGH P/E: WHAT IS BETTER?

With expensive stocks getting more expensive, there exists considerable confusion in an investor’s mind whether to construct a portfolio with low p/e stocks which, traditionally, is a preferred strategy to beat markets or include more high p/e stocks in the portfolio. Geyatee Deshpande shares her unique perspective on a topic that concerns a majority of investors

- Geyatee Deshpande

“How can a stock trading at 1,000 + p/e multiple be one of the big gainers in 2019? I am talking about 63 Moons Technologies Ltd. here. It has generated returns in excess of 42 per cent in 2019 alone and the price multiple it is trading at is unbelievable. Isn’t it an expensive stock– even for a long-term investment?” asks an investor to the expert speaker in an investor awareness programme. The investor is obviously a little confused on how to interpret the p/e ratios and is finding it difficult to digest the fact that a stock with such a high p/e ratio can not only deliver positive returns but also do better than a majority of low p/e stocks that are supposed to do well – this being the perception.

Indeed, the year 2019 saw lots of high p/e stocks outperforming the market and especially those that reflected low p/e stocks. If that is the case, should the investors not adjust to the new reality (upward shift) on p/e multiples? A p/e ratio of 18 may sound normal today but during 1990s the same p/e must have looked extremely expensive. As time passes, the way market prices of the stocks change, there is always a possibility of a shiftin the p/e ratios – mostly upwards. To get to the bottom of the story we need to first understand what influences p/e ratio and how best can a market-beating portfolio be constructed using p/e multiples.

What Influences P/E Multiple?

Price to earning ratio is simply a ratio of market price per share to the earnings per share of the concerned company. Basically, the following types of stocks have shown tendencies to reflect lower p/e ratios: