Hi everyone welcome to today’s article. So take a look at this particular chart, it is of Nestle Pay Ratio. what you will see is that Nestle was trading at around PE of 50 in 2010. then it was at that mark hovered around and then it was over. Over the years the PE has generally increased and now Nestle is trading at 89.90% PE. Now the reason why I am telling you this story is quite simple. because in 2010 if you had seen the PE of Nestle, you would say 50 PE? who will be going to buy it? crazy people will buy it. it is an over-valued stock, let me discard it. because I learned to buy a stock if PE is less than 30 and if pe is over 30 it is overvalued. let’s take a look at Nestle’s stock price rise. so in 2010, Nestle was trading at around 2500-2600 Rs and now it is trading at around 18,000 Rs. Now the stock has increased almost seven times, yet it has had a very high return since 2010. Why am I now telling you this story because I get a lot of comments like, “This stock is overpriced because the P is so high”, “if you buy it and you will ruin your financial”, “you know coal India is trading at pe of 6 and 7, I really should jump on that stock because it has so good pay”.
So in this article, I will explain what you should do. what are undervalued stocks and where and where this pay ratio doesn’t make sense to use super interesting articles? read it till the end and also hit the like button so that this article will help to reach more and more people and make them more aware of the stock markets.
How to Pick Undervalued Stocks
What is PE Ratio?
So first and foremost let me help you understand what is the exact meaning and interpretation of the PE ratio. so PE ratio formula says that P means stock price divided by E (earnings per share). Now how do you calculate stock price or earnings per share? you don’t need to use maths. basically, the PE ratio is always given to you. so you can just go to any screener and identify the PE ratio of the stock. so that you need a mathematical model to find your own PE ratio. Needless to say, what is important to you as an investor is to understand what is the meaning behind the PE ratio. let me illustrate this point by giving you two specific examples. example number one would be Nestle. as I showed you That Nestle Pay is around 89.90. so what does it mean? it is an important statement that to make one rupee from Nestle stock you need to invest 89 rupees. which indicates a PE of 89. the PE Ratio of Coal India is 7 then what does it represent? it indicates that to make 1 Rs. from Coal India you have to invest Rs 7 as an investor at current prices. so this formula also explains and This is the easiest explanation you can find anywhere.
Does High PE Ratio Indicate Good Stock?
Now you will say ok, it seems so obvious that why would I ever go into a stock like Nestle when I am getting something like Coal India for seven bucks? I will just put my money there because I just have to invest less to make the same one rupee. here I have to invest 89 rs to make the same one rupee. so only a crazy person will go and invest in something like nestle. but here is the fundamental problem with that principle. you and I as investors are interested in future stock prices. the current price is not per instance. for example if you and I buy Nestle today, we are buying it with the expectation that the Nestle stock will increase in the future. similarly, if you are buying low-pay stock, So we are buying again this is with the expectation that this stock will go up in the future. also so we are more concerned about the future. so what is it that we are worried about? we are worried about the price hike not necessarily the stock. What is the current PE of For example, when we say that Nestle is trading at a PE of 90, why would a crazy person buy it? because of this equation and one is that people expect the earnings per share to go up in the future. as a result, the entire PE will go down. So buying a higher value stock can also be a wise move.
So when you see a stock with a very high PE, there are two basic explanations for this. One is that the stock may actually be overvalued. That you know that it has no growth potential and the stock is highly inflated. which is an important explanation and in such circumstances, you should avoid buying such stock. but another explanation could be that the growth prospects of that stock or That industry may actually be overpriced and it may make sense to buy that stock. even when the PE is quoting very high. which is why Nestle came with a very high PE in 2010. despite this, it is growing continuously. even its PE is still increasing and growing along with the company. hope I should talk about low pay and low growth company. should you just go and buy a company because it is low PE? so here a classic case would be coal India. so if you are looking for coal India stock, take a look at the pay. you’ll see seven oh, it’s kind of super cheap. let me just go and buy it. why take a look at this. for example you can see that the pe of this stock even since 2010 Anything less than 30 is trading low. traditionally considered a low pay stock. so it’s always trading something less than 30. in fact, its PE has fallen all the way to 9 or 10 here and there. Then climbed up and climbed on it and now it is trading roughly at 7. At any stage, it makes sense to buy such a stock. Let’s see if this stock would generate wealth for its shareholders. On stock returns from 2011, you can see that it was trading at 320. it went to max 439 and now it is, unfortunately, trading at 167. So in short you need to remember these two key points, high PE plus high growth companies do not necessarily nest it. for example, a high PE can happen but as long as this growth remains active, as long as it is more and more Keeps giving returns.
On the flip side point number two, there is no problem in buying such companies. even on high PE, many companies have low PE and very low growth potential. please don’t buy such companies because if you buy them on the app of seven. so now the obvious question will come, is ok does this mean pe ratios are too much waste? the answer is yes. they are pretty much wasted in my opinion.
But there are two important things which you must remember and that makes pay ratios somewhat useful. Please read more about it in my next article.
- What is PE Ratio for Stocks | Price-to-Earnings Ratio
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