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Perils of treading the PE path

Last week, I was interviewing a fresher. His enthusiasm for stock markets was infectious. He excitedly opened his mobile to show me the list of stocks he had filtered using online financial screeners.

He was going to start investing in, what he thought were, stocks that the rest of the market had not ‘discovered.’ And at prices that he thought were true ‘value.’ Not surprisingly, I found many of his low PE stocks were value traps or worthless.

If you are a new investor like him, running screeners through equity apps to pick your stocks, here’s what you need to know about the PE ratio.

PE ratio is nothing but the measure of the price of a company’s stock as a multiple of the earnings that a company generates/seeks to generate. The PE ratio is calculated either using the current earnings per share (annualised) or the trailing, four-quarter earnings or the expected earnings per share (forward PE).

Many stock market crash courses will teach you to ask yourself whether a company will grow at the rate of its PE. For example, when a stock’s PE is 35 times, the question you are required to pose is whether you expect a 35% growth in the company’s earnings.

 



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