Are stocks with a low PE ratio generally safe to buy?

From the concept put forth by the Father of ‘Value Investing’ – Ben Graham, it is normally an accepted norm that a low PE ratio should be considered a value buy.

Father of Value Investing & Warren Buffet’s Teacher – Ben Graham

This though is not the entire fact

Why so?

The reason is, we need to understand something called the ‘Intrinsic Value’ of the stock/equity.

According to Graham,

Stock Price > Intrinsic Value → Stock is Overpriced

Stock Price < Intrinsic Value → Stock is Underpriced

Stock Price <= Intrinsic Value → Stock is Aptly Priced

The formula for Calculating Intrinsic Value

Considering this, the stock with low PE cannot be always considered a value buy.

The underlying theme for buying low PE stocks will be

PE Formula

Accordingly,

  1. Low PE Stocks – Utilities, Oil Companies, etc.
  2. High PE Stocks – Pharma, IT, ITes, etc.

Let us look at two examples from the Indian Stock Market for different PE stocks over a 5-year Period

IOCL (Indian Oil Corporation Limited)

  • PE < 10
  • Returns: -36% (Wealth Destroyer)
Stock Performance of IOCL over the 5-Years

TCS (Tata Consultancy Services)

  • PE > 25
  • Returns: +220% (Wealth Creator)
Stock Performance of TCS over the 5-Years

Hope this helps

You can follow my blog or Facebook page on investing for getting insight into other stocks.

Happy Investing!!

References:

  1. Intrinsic Value vs. Current Market Value: What’s the Difference?
  2. Intrinsic Value Formula
  3. Price-to-Earnings (P/E) Ratio
  4. Low PE Stocks in India [2022] – What is The Significance of Low PE? – GETMONEYRICH

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