Going beyond PE ratio!

Price-to-Earnings (PE) ratio is one of the most popular tools used by investors throughout the world for judging whether a stock is over or undervalued at the current market price. One compares PE with the overall market’s PE (PE of a broader market index), industry peers and the company’s own past PE values. If PE of a company is substantially greater than the values we are comparing it with, then, one can form an opinion on the stock’s valuation relative to some other stock or a group of stocks.
However, thinking that high PE stocks are expensive is a misconception that can hurt an investor because one has to also factor in the growth potential, quality and moat of the company. Generally, companies with dominant market share, good management, corporate governance and visible growth prospects command a higher PE vis-a-vis their peers.
Thus, a better matrix would be factoring in such things into one’s analysis. A better ratio than PE would be PEG ratio-PE to growth rate ratio. Here, the higher PE stocks with a high growth rate will show more tolerable numbers, as compared to high PE stocks with a lesser growth rate.
Few examples in India, where companies have high PE due to some factors as growth prospects, good market share and strong corporate governance are- Hindustan Unilever Limited (HUL), Avenue Supermarts, Titan, Asian paints and Pidilite Industries.