Expert: Paul Henneman - 8/26/2009

Question
I wanted to know the standard or cut-off P/E by which we can decide to buy a stock or not.

Answer
Darshan,
  Thank you for your question! Unfortuantely, this is not as simple as stating a specific P/E ratio to invest in a stock.
   Every investor would likely have a different answer to this question. Investors that take a great deal of risk, looking for stocks that will rise the most, typically look for high p/e ratios. This is basically a momentum play, in that the stock has run up and will continue doing so. It is very risky, and easy to lose your investment. But it can also offer high reward.
    Other investors are more buy and hold type investors, lookoing for the lowest p/e ratio possible.
   To complicate things further, what is a low p/e? this changes dramatically over time. What would have been very low when comparing to the overall market two years ago, could be even lower today as p/e ratios have dropped substantially.
   I suggest several things. First, decide what kind of investor you are. Are you looking for very large returns in a short time period? You then need to invest in risky stocks, high momentum, and they probably have comparatively very high p/e's compared to their competitors and industry group. Or, if you are looking for long term investments that are fairly stable and offer a much great chance of profits every year (but lower levels of profits), then you want to seek out lower p/e ratios.
   But never look at p/e ratio alone. A stock could have a low or high p/e ratio for the wrong reasons. It is just a starting point. P/E should be used comparatively, meaning how the p/e compares to competitors and the average p/e of the industry is far more important than what the actual p/e is.

I hope that this helps. Please do not hesitate to follow up with me if I can be of any further assistance.

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com