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Last Updated : Jan 18, 2019 03:55 PM IST | Source:

Stock Market Classroom with Udayan Mukherjee: How reliable is price to earnings as a valuation indicator?

Investors should focus on P/E multiple along with growth of a business

Udayan Mukherjee

Price-to-earnings (P/E) ratio gives unsophisticated or lay investors a sense of a value of a stock or company. It helps determine business valuation in relation to profits and expected profit growth. But beware as, at times, this valuation parameter too can be misleading.

Investors may choose to ignore a stock trading at a high P/E. But instead of ignoring such businesses (like Page Industries and HDFC Bank), investors should be looking at these as a high P/E multiple indicates investors are expecting significant growth in 3-5 years, and thus higher returns.

Likewise a low P/E may also indicate lack of growth potential in a business. For instance, metal companies may be trading at a low P/E but as these are cyclical businesses growth expectations are low. Instead, investors should focus on P/E multiple along with growth of a business.

So, how should one trade using P/E multiples? And, more importantly, when should investors use forward P/E multiples and when should they use trailing P/Es? For the answer to all these questions, click on the accompanying video…

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First Published on Dec 13, 2018 08:25 am
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