InvestorQ : What are the cautions when buying a stock with low P/E ratio?
Neelam Naik made post

What are the cautions when buying a stock with low P/E ratio?

Dawn Cherian answered.
3 years ago
Have you ever wondered why Hindustan Unilever and Britannia get fancy valuations but ONGC gets tepid valuations? The answer could lie in growth or rather in perceptions of growth. There are some clear trends that are visible when it comes to P/E ratios in India. Consider a few classic cases. The P/E ratio of FMCG stocks and pharma stocks normally tend to be high because they have shown consistently high levels of growth and ROE. On the other hand, IT stocks have seen their P/E ratios shrinking from 30+ levels to sub-20 levels as global tech spending has been shrinking and Indian IT companies are seeing their growth rates and their ROE taper. Then there are companies in the steel and PSU banking space, where they always tend to quote at very conservative P/E ratios of less than 10. In the case of metals, the risk is on metal prices which are vulnerable to global shifts while in case of PSU banks the fear is that NPAs could dent their growth and ROE in a big way.
Using P/E ratio to value a stock is fine as long as it is able to factor in the growth aspects. A very good example is D-Mart which is already one of the most expensive retail stocks in the world with valuations at over 60 times earnings. That is because the market is building in very aggressive sales growth over the next 5 years, aggressive growth in ROE and reduction in debt. Growth, therefore, becomes a key factor when using P/E ratio to value a stock.