Conscious Investor Knowledge Base

Is it better to invest in stocks with a low PE Ratio or a high PE ratio?

The PE ratio is defined as the current price divided by earnings per share. You can think of the PE ratio as the amount that the market is willing to pay for $1.00 of earnings per share. For example, a PE ratio of 15 means that the market is willing to pay $15 for each $1.00 of earnings per share.

Generally speaking, stocks have a high PE ratio because the market believes that earnings will growing rapidly in the future and they have a low PE ratio because the market believes that growth will be more modest.

People who invest in stocks with a high PE ratio are often referred to as growth investors and people who invest in stocks with low PE ratios are often referred to as value investors. However, the use of the term value here is misleading because all investing (as opposed to speculating) is looking for value.

The important thing is to look for value, no matter whether the PE ratio is high or low.

However, if the PE ratio is very high, the price of the stock can drop significantly if the earnings growth stops or slows. For this reason, it is important to take extra care when investing in “high PE” stocks.

This means, for example, when doing a STRET or STRETD calculation in Conscious Investor to include a larger margin of safety.




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Last Updated
1st of July, 2008

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