When it comes to selecting stocks, probably people love to look at a list of top low PE stocks.
The use of stock valuation tool, the Price to Earning Ratio (PE), is one of the most used stock valuation tool after EPS.
PE ratio is one of those calculations about stock valuation that is easiest to do.
In most cases, one need not calculate PE ratio of stocks. It is readily available on internet.
Nevertheless, calculation of PE Ratio of stock is simple.
But we must understand well how to effectively use PE ratio for stock valuation.
For some, PE ratio of stock is a complete valuation tool. For others, it serves very little purpose.
Due to this varied opinion PE is also the most misused tool.
It is true that there is no ratio which speaks as loudly about stock valuation as PE ratio. But is PE ratio in itself complete? One must use it in combination with other financial ratios?
Surely, isolated use of PE ratio is not advisable. But no way one can diminish the utility of PE ratio. Even today, a lot of people start their screening process from low PE stocks.
As a starting point, preparing a list of low PE stocks is advisable. Once this list is ready, a detailed fundamental analysis of individual stock is a must before investing.
In this post we will see a method to use PE ratio more effectively.
Earning Per Share (EPS) is PAT per share of last financial year (trailing EPS).
PE ratio seen on internet are calculated using trailing EPS. Market price divided by EPS gives us the PE ratio of a stock.
Theoretically, PE ratio of stocks should be below 15. Stock with PE above 15 can be considered overvalued.
This is a universal rule? No.
It is essential to look beyond the PE15 rule.
There can be a condition where PE ratio of a stock is above 15, but still it is undervalued.
You are surprised? Yes I can understand. When I first read about this, I was both surprised and confused.
I was surprised as I didn’t expected someone to tell me this fact. I was confused as this one statement made me doubt everything that I have learnt about stock valuation.
In this article we will dig slightly deeper into the concept of low PE stocks.
What it means when stocks are trading at PE ratio of 15,20,25,30…?
Market price of stock is directly related to its EPS.
Suppose two stocks A & B has same EPS of 5. But PE ratio of A is 15 and that of B is 25. It means, B is more overvalued than A.
PE is the first hint to investors about the stock’s valuation.
But for trained investors, what is more important is why PE ratio of of any stock is high or low?
For blue chip companies, PE ratio generally trade at very high levels. Why?
Because, future EPS growth rate of blue chip companies are more predictable. Hence investors are ready to pay higher price to buy their stocks.
But does this mean that all high PE stocks have predictable future growth? No.
Speculative factors also push market price of stocks high. Hence, we can say that irrespective of PE ratio being high or low, one must not take the investment decision based on PE ratio alone.
Important is to looke deeper into the PE ratio.
When we are looking at PE ratio, we must also understand why PE ratio of this stock is high or low.
Q1: If stocks PE ratio is high due to its high growth potential, or due to speculative forces?
Q2: If stocks PE ratio is low due to its diminishing growth potential, or due to speculative forces?
Answering these questions before committing to a stock is essential for investors.
When speculative forces dominate, stock price touch unreasonable levels. It is investors responsibility to evaluate, if speculative forces are dominant on a stock pricing.
Here will talk more about low PE stocks. Idea is to learn to evaluate if low PE stocks are good buy or not.
Low PE stock, with weak fundamentals is not interesting.
Low PE stock which also has strong fundamentals can be a great contender for investing.
Why we need PE ratio?
Looking at market price of stocks is not enough
There are people who buy/sell stock by looking only at its market price. This is like investing blindly.
Looking at PE ratio, to value a stock, is at least better than looking only at its market price.
What a PE ratio does is this, it checks how high is the market price of a stock compared to its EPS.
Suppose there are two stocks A and B. Both has a market price of Rs.100. Stock A has EPS of 10, and B has EPS of 15.
Hence PE ratio of the two stocks is as follows:
- PE (A) = 10.00 (100/10)
- PE (B) = 6.66 (100/15)
After we look at the PE ratios of A and B, it is giving a clear hint that B is better valued than A.
What is important here is to note that, how comparing PE of A and B gave us an idea of which stock is better valued.
We need PE ratio to compare price of two stocks and arrive at a conclusion.
The company with lower PE ratio is better priced than the others.
PE Ratio alone is not Enough…
Frankly speaking, just by looking at PE ratio of stock, says too less about the stock valuation.
So what is the alternative? Do a more detailed analysis.
Factoring in a another stock metric can greatly enhance the utility of PE ratio.
Embedding in the PE ratio, the EPS growth rate, will give more understanding about the stocks true valuation.
Lets take an example:
There are two Stocks ABC and XYZ. Metric of these two stocks are as below:
- Market Price (ABC) : Rs.100
- EPS (ABC) : Rs.5
- PE (ABC) : 20
- Market Price (XYZ) : Rs.50
- EPS (XYZ) : Rs.2.5
- PE (XYZ) : 20
Which stock is better valued?
As PE ratio of both ABC and XYZ is identical (at 20), it is like impossible to judge which is better priced.
So what to do now?
We can analyze ABC and XYZ based on their growth potential.
One of the important parameter that tells us best about the future growth prospects of a stock, is its historic EPS growth rate.
Peter Lynch says, a fast growing stock can afford a higher PE ratio and still remain undervalued.
Suppose the EPS growth rate of ABC is 18% per annum, and that of XYZ is 22% per annum.
Dividing PE with EPS growth rate will give a value which is termed as PEG ratio.
Lets calculate the PEG ratio of ABC and XYZ.
- PE (ABC) : 20
- EPSG (ABC) : 18
- PEG (ABC) : 1.11 (20/18)
- PE (XYZ) : 20
- EPSG (XYZ) : 22
- PEG (XYZ) : 0.91 (20/22)
Which stock is better priced?
As a rule of thumb, a stock which has a PEG of below one (1) is said to be undervalued. Comparatively, lower PEG means better valued.
In our example, as PEG of XYZ is lower (0.91) than PEG of ABC (1.11), hence B is better valued than A.
Use PE ratio as a tool to value good stocks.
Calculate Price Earning Ratio (PE) easily by dividing market price of a share with its EPS.
How this PE ratio is helpful for investors?
Market price of a stock will tell only about how much a stock is valued by the market. It is just a speculative indicator of valuation.
EPS tells us how much profit the company has generated per share.
A combination of market price of a stock and its EPS gives us PE ratio.
Generally market always overrates good stocks. Use PE ratio to gauge stock’s true value.
There is so much fuss being created about undervalued and overvalued stocks, why?
Undervalued stocks makes money for its investors. While investing in overvalued stocks leads to losses.
It is essential for stock investors to avoid overvalued stocks.
Use of low PE ratio along with PEG ratio, is a great way to identify undervalued stocks.
A stock which is trading at low PE ratio (of say below 15) and also has a PEG below 1, makes it very interesting for value investors.
Low PE Stocks in India with its PEG Ratio 2018
(Updated as on April’2018)
- Balrampur Chini Mills Ltd.
- Mangalore Refinery & Petrochem.
- NLC India Ltd.
- Chennai Petroleum Corpn. Ltd.
- GHCL Ltd.
- Hindustan Petroleum Corpn. Ltd.
- Indian Oil Corpn. Ltd.
- DCM Shriram Ltd.
- Rural Electrification Corpn. Ltd.
- Suzlon Energy Ltd.
Click this link to see a list of 50 number Low PE ratio stocks with their PEG Ratio (1 year, 3 year and, 5 year) in a tabulated form…
* P.Note: P/E Analysis of companies has been done without evaluating companies business fundamentals.
Disclaimer: All blog posts of getmoneyrich.com are for information only. No blog posts should be considered as an investment advice or as a recommendation. The user must self-analyse all securities before investing in one.