How to calculate low PE ratio shares?
Calculating the PE (Price-to-Earnings) ratio helps investors determine if a stock is undervalued. The PE ratio is derived by dividing the current market price of a stock by its earnings per share (EPS). A lower PE ratio indicates a potentially undervalued stock, but investors must analyse other financial metrics before making decisions. Here is how to calculate and identify low PE ratio shares:
- Determine the stock price – Check the latest market price of the stock from a reliable financial platform.
- Find the earnings per share (EPS) – EPS is calculated by dividing the company’s net profit by the total number of outstanding shares.
- Calculate the PE ratio – Use the formula: PE Ratio = Market Price / EPS.
- Compared with industry peers – A low PE ratio compared to sector averages can indicate undervaluation.
- Analyse financial health – Check revenue growth, debt levels, and profitability to ensure the stock is fundamentally strong.
A low PE ratio alone is not enough; investors should consider market trends, economic conditions, and industry outlook before making investment decisions.
For example:
Say the current market price of a listed company is Rs. 150, whereas its EPS is Rs. 25. The PE ratio of this company would be 6 times (Rs. 150 / Rs 25). It implies that investors are willing to pay six times the company's annual earnings to buy each share.
How is the PE ratio used in stock investing?
PE ratio indicates whether a stock is:
- Overvalued
- Undervalued, or
- Fairly valued
See the table below to understand how this assessment is made:
| Overvalued |
Undervalued |
Fairly valued or low PE stocks |
| An overvalued stock has a high P/E ratio compared to its peers or historical averages. |
Undervalued stocks have low P/E ratios relative to their peers or historical averages. |
A fairly valued stock has a P/E ratio in line with industry norms or historical averages. |
Why invest in low PE ratio stocks?
Low P/E ratio stocks represent undervalued assets and are favoured by value investors. It indicates that:
- The stock is trading at a discount relative to its earnings potential
- Investors have an opportunity to buy quality companies at a lower price
Investors who hold positions in low PE stocks often benefit when:
- The market recognises the undervaluation and
- Revalues the stock upwards
This helps in capitalising on capital appreciation as the stock price increases to reflect its true value and generates higher returns.
Furthermore, some low P/E ratio stocks offer attractive dividend yields. Companies with stable earnings and strong cash flows choose to return capital to shareholders in the form of dividends. Thus, investing in these stocks not only provides the potential for capital appreciation but also offers regular income through dividends.
Strategies for identifying low PE ratio stocks
Following are tips and strategies for identifying low PE ratio stocks:
1. Use stock screeners
Stock screeners are online tools that allow investors to efficiently filter and identify stocks based on specific criteria, such as the price-to-earnings (PE) ratio. By applying filters, investors can quickly find shares with low PE ratios, enabling them to discover opportunities like undervalued stocks with potential for growth. These tools streamline the process of locating low PE, high-growth stocks or shares with attractive valuations.
2. Analyse company financial statements
A thorough review of a company's financial documents—such as the balance sheet and income statement—can provide insights into its earnings and current valuation. By manually calculating the PE ratio, investors can identify companies trading at a lower valuation relative to their earnings, highlighting potential opportunities among low PE ratio stocks.
3. Look for undervalued stocks
Fundamental analysis and valuation techniques can help uncover undervalued stocks with low PE ratios. Investors should evaluate intrinsic values, earnings potential, and other metrics to determine if such stocks are priced below their true worth. This approach is particularly valuable in markets like India, where low PE stocks may be overlooked or undervalued.
4. Consider investing in index funds or ETFs
For investors seeking diversified exposure to low PE ratio stocks, index funds and Exchange-Traded Funds (ETFs) are an effective option. Certain ETFs track indices like the Nifty Low Volatility 50 Index, which includes low-volatility stocks with reasonable PE ratios. These funds often incorporate public sector undertaking (PSU) stocks, offering access to stable and undervalued investments with lower PE ratios.
While these strategies are useful, investors must undertake thorough research or consult a financial advisor to make informed investment decisions.
Features of low PE stocks in India
Following are the key features of low PE stocks in India:
1. Value proposition
Low PE ratio stocks generally indicate companies trading at a lower valuation compared to their earnings, offering an attractive opportunity for value investors. Such stocks may represent assets that are undervalued relative to their intrinsic worth, particularly for those looking for low PE, high-growth investments.
2. Risk and volatility
While low PE ratio stocks can offer significant opportunities, they may also carry higher risk and price volatility. Investors should assess their risk tolerance and evaluate the likelihood of price fluctuations before committing to such stocks.
3. Market sentiment and perception
A low PE ratio can reflect prevailing market sentiment or challenges faced by a company. Understanding the underlying reasons, such as temporary setbacks, sector dynamics, or market trends, is critical for determining whether the stock is genuinely undervalued or signals deeper issues.
4. Dividend yields
Some low PE ratio stocks provide attractive dividend yields, making them appealing to income-focused investors. Evaluating a company's dividend history and policies can help determine whether these stocks align with income-generating investment goals.
5. Sector dynamics
The nature of low PE ratio stocks often varies by sector. For instance, certain industries may consistently exhibit lower PE ratios due to their growth trajectories or market conditions. Assessing broader economic and industry trends is essential for understanding and contextualising the significance of a low PE ratio within a specific sector.
By recognising these features, investors can better evaluate opportunities presented by low PE ratio stocks while aligning their decisions with financial goals and risk preferences.
Why are low PE ratio shares popular?
Low PE ratio shares are favoured by investors because they often indicate undervaluation, offering potential for strong returns. These stocks are considered attractive for long-term investment as they provide opportunities to buy quality businesses at lower prices. Here is why they are popular:
- Value investing appeal – Many investors seek undervalued stocks with strong fundamentals, expecting future price appreciation.
- Potential for high returns – Stocks with low PE ratios may experience a price correction when market sentiment improves.
- Lower risk of overvaluation – Unlike high PE stocks, these shares are less likely to be overpriced or speculative.
- Stronger dividend yields – Many low PE stocks belong to established companies with steady earnings, offering good dividend payouts.
- Sector-specific advantages – Cyclical industries, banking, and commodities often have lower PE ratios, attracting sector-focused investors.
Despite their popularity, investors must assess financial health, business growth, and industry trends before investing in low PE ratio stocks.
Conclusion
Profit-to-equity (PE) ratio is the relationship between the current market price of the share and its (EPS). Low PE stocks are often considered attractive investments as they offer capital appreciation opportunities to investors. Some popular low PE stocks in India are Oil and Natural Gas Corporation Ltd., Coal India Ltd., State Bank of India, UPL Ltd., Hindalco Industries Ltd., and Power Grid Corporation of India Ltd.
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