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.
This though is not the entire fact
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
Considering this, the stock with low PE cannot be always considered a value buy.
The underlying theme for buying low PE stocks will be
- Low PE Stocks – Utilities, Oil Companies, etc.
- 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)
TCS (Tata Consultancy Services)
- PE > 25
- Returns: +220% (Wealth Creator)
Hope this helps