P/E not best tool to value a stock. Which ratio to apply to which sector? (2024)

FAQs

What sector PE ratio is good? ›

As far as Nifty is concerned, it has traded in a PE range of 10 to 30 historically. Average PE of Nifty in the last 20 years was around 20.* So PEs below 20 may provide good investment opportunities; lower the PE below 20, more attractive the investment potential.

For example, a low P/E ratio could suggest a stock is undervalued and worth buying. However, including the company's growth rate to get its PEG ratio might tell a different story. PEG ratios can be termed “trailing” if using historical growth rates or “forward” if using projected growth rates.

The biggest limitation of the P/E ratio: It tells investors next to nothing about the company's EPS growth prospects. If the company is growing quickly, you will be comfortable buying it even it had a high P/E ratio, knowing that growth in EPS will bring the P/E back down to a lower level.

It is far more likely that any P/E increase will be the direct result of eroding earnings or lower EPS, which isn't the way investors would like to see a bullish rise in a company's P/E.

Healthcare companies often have lower P/E ratios due to regulatory risks and high research and development costs. Consumer goods companies typically have moderate P/E ratios due to the steady demand for their products.

Sector PE ratio is calculated as market capitalisation of the sector divided by gross earnings of the sector. Market capitalisation of the sector is calculated as the sum total of the outstanding equity shares multiplied by the close price for each company of the sector.

P/E ratio, or price-to-earnings ratio, is a quick way to see if a stock is undervalued or overvalued. And so generally speaking, the lower the P/E ratio is, the better it is for both the business and potential investors.

This can be due in part to the consistency of earnings, the anticipation for increased earnings, and the industry group that each stock is in. If investors are excited about the prospects for a given company, they may be willing to accept a higher P/E ratio in order to buy its shares.

As of today (2024-07-30), Best Buy Co's share price is $84.83. Best Buy Co's Earnings per Share (Diluted) for the trailing twelve months (TTM) ended in Apr. 2024 was $5.71. Therefore, Best Buy Co's PE Ratio (TTM) for today is 14.86.

The most common use of the P/E ratio is to gauge the valuation of a stock or index. The higher the ratio, the more expensive a stock is relative to its earnings. The lower the ratio, the less expensive the stock. In this way, stocks and equity mutual funds can be classified as “growth” or “value” investments.

What if PE ratio is less than industry PE ratio? ›

If a company's PE ratio is lower than its industry's average then it signifies that the company might be having more debt in the books relative to its peers or might be losing market share or might be having lower profit margins relative to its peers or there is some governance issues in the management.

Accounting rules can change, shifting reported earnings without any real change in the underlying business. The large number of accounting loopholes makes it easy for executives to mislead investors. PE ratios overlook assets and liabilities that have a material impact on valuation.

Typically, the average P/E ratio is around 20 to 25. Anything below that would be considered a good price-to-earnings ratio, whereas anything above that would be a worse P/E ratio. But it doesn't stop there, as different industries can have different average P/E ratios.

A low P/E ratio might indicate that the current stock price is low relative to earnings. An investor could look for stocks within an industry that is expected to benefit from the economic cycle and find companies with the lowest P/Es to determine which stocks are the most undervalued.

P/E ratio's effectiveness at Individual stock level

When this return is positive, it means the P/E ratio is effectively identifying under- and over-valued stocks. Notice that this effectiveness has been steadily declining over the last two decades, and is now worse than random.

Average P/E Ratio for the Financial Services Industry

Specifically, investors study the P/E ratios of brokerage firms, banking operations, asset managers, as well as debt and credit service providers. To cite an actual example, on August 2021, the average P/E ratio of the financial services industry was 7.60.

The current P/E ratio for the retail sector, an average of the subsectors' ratios, is 64.65 (current as of January 2021). The average trailing P/E ratio for the retail industry in January 2021 was 22.70.

P/B Ratios and Public Companies

Traditionally, any value under 1.0 is considered desirable for value investors, indicating an undervalued stock may have been identified.

A P/E ratio of 5 could be considered good or bad depending on the industry and the company's growth prospects. For example, the industry average P/E for oil and gas companies is 6.3. This means that if an E&P company is trading for below that, the company is currently priced cheaper than the industry average.