Most of us perceive it incorrectly that lower the PE the better the stock is because it is undervalued just beacuse price is lower or Earnings are high or both. Let consider other factors as well to make a wise investment in stocks.
Stability : Stability in earnings, One should always realise that company manufacturing umbrellas will have stable earnings in rainy season. Whereas the revenue will not be recognised during summers. So it is important to divest once rainy season ends. So stable earnings are important. The better the earnings the better the retention reserve and better the growth of the company.
Growth : It is important to understand how efficiently the management is utilising its retention reserve for further growth. If the managemant is investing its funds in Govt securities even investor can manage his funds by investing in such risk free assets. So why do an investor should take a risk by investing in stocks of companies which invest their retention reserve in Govt sec and not for futrther expansion. This means management is no more efficient and lags any innovatiove thoughts. The product must have reached a maturity stage and shall soon enter a decline stage.
Dividends : Companies which pay high dividends have lower EPS which will make PE ratio high. But dividends are income to share holders which should be considered as far as return on stocks is concerned.
Leverage : Operating leverage and Financial leverage are also important to understand the performance of firm.
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