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.

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

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

The underlying theme for buying low PE stocks will be

• Earnings in terms of the Capital Employed (ROCE)
• Dividend Yield
• Future Cash Flow Prospects

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)

TCS (Tata Consultancy Services)

• PE > 25
• Returns: +220% (Wealth Creator)

Hope this helps

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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