Are stocks with lower PE always good?

Price to earnings ratio, a.k.a PE ratio is a financial ratio used for analysing companies for investment purposes. This ratio helps to assess whether a stock is trading at a fair valuation. Generally, a lower PE is considered better. However, it may not always be the case. Let’s take a look at the pros & cons of investing in a stock that is trading at a PE lower than its industry PE.  

Pros:  

• There is a good chance that the stock might be undervalued. In this case, the market has not yet discovered/recognised its true or intrinsic value yet. Such a scenario poses a good opportunity for value investors as they prefer to buy stocks at a lower valuation, and book profits when the market recognises the fair value of the stock.    

• On the other hand, the lower PE may be due to the occurrence of a short-term event, or a temporary situation such as the macroeconomic event, overall market slowdown, etc. In this case, the company might recover after an improvement in the situation.  

• Moreover, a stock with a PE that is lower than its industry PE exhibits potential for significant growth.  

Cons:  

• On the downside, the undervaluation can be a result of the company losing its profitability. This could be due to reasons such as entry of new competitors, rise in the cost of raw materials, poor managerial decisions, inability to keep up with evolving needs of the consumers, etc.  

• Another risk that comes with investing undervalued stocks is that an investor’s analysis can go wrong, and the stock might not appreciate in value as he had expected. Furthermore, he will have to stay invested for a longer period of time as in, till the market recognises the stock’s intrinsic value.