Monday, 6 February 2012

A Subnormal P/E

When a stock is selling at a P/E significantly lower than that of its competitors, an investor will want to know why?

A low P/E does not necessarily mean higher risk, though the company should be studied with that possibility in mind.

  • The low P/E stock may be selected anyway if, for example, it is a cyclical stock at a low in its cycle.   Cyclical stocks - automobile manufacturers are the most notorious among them - periodically develop fire-sale P/E ratios.  
  • Other out-of-favour stocks also can drop to surprisingly low P/Es.

On the other hand, if a stock is cheap in terms of its multiple for a troubling reason (or permanent deterioration of  business  fundamentals), such as pending depletion of oil or mineral reserves or a patent expiration, the value investor may want to shop elsewhere.

Often the low P/E is appropriate for the stock as it is perceived to have poor potential for growth or its earnings are poor, volatile and less stable.

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