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The general rule with Price-Earnings ratios (P/E) is that the lower a stock’s p/e, the better. And a P/E of less than, say, 10, represents excellent value. A low P/E implies more profit for every dollar you invest. However, P/E is only the starting point in researching stocks. Here are some gotchas that you should be aware of:
- One-time gains can artificially inflate a company’s P/E: When a company sells assets, it enjoys a one-time bump in earnings that might make the P/E ratio artificially low. And similarly when there are one-time write-offs, P/Es get high. In either of the two cases, P/E is not a gauge of the company’s true ongoing operating earnings.
- A low P/E can be a danger sign: Low P/Es may come about because well-informed investors are selling the stock and pushing the price down, regardless of earnings. In other words, unusually low p/e’s can be a sign of danger rather than a clue to a bargain. For example, the 2.73 PE of Aarvee Denims
- Don’t ignore stocks with high P/E: Growth stocks have naturally high P/Es. You should expect to pay more for companies with long-term earnings potential. However, stocks with high P/Es tend to be more vulnerable during periods of broad market setbacks. For example, the nearly 205 PE of Adani Enterprises that has a 50-day volatility close to 80%.